I'm a big fan of high-yield dividend stocks. However, if there's one thing I've learned in my years of investing, it's that yields tend to increase when the market grows concerned about their sustainability. Those alarm bells get loudest as they rise into the double digits.
That's clearly the case at Martin Midstream Partners (MMLP -2.20%). The master limited partnership (MLP) currently offers investors an eye-popping payout yielding 16.2%. While that gargantuan income stream might seem alluring, there's a high risk that it won't last very long. That's why I wouldn't dare touch it these days, because I believe it will eventually burn income investors.
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Drilling down into the numbers
Martin Midstream is coming off a tough year. The company initially anticipated that it would generate enough cash to cover its generous distribution by more than 1.25 times, which is a comfortable level for an MLP. However, crashing crude prices during the fourth quarter -- which is historically a strong one for the company -- significantly impacted its results. As a result of this and other issues, Martin Midstream only hauled in enough cash to cover 69% of the money distributed to investors last year.
Making matters worse, the company's balance sheet was already in a weakened state because it had routinely borrowed money not only to bridge that gap but to invest in expansion projects. As a result, leverage ballooned to 5.46 times debt to EBITDA by the end of the second quarter, which was well above the 4.0 times comfort zone of most MLPs. That metric, however, did come down to 4.61 times by year-end after the company sold its interest in a pipeline system for $193.7 million.
Getting better but still unstable
That sale was one of two strategic initiatives that Martin Midstream has undertaken over the past year to strengthen its balance sheet, reduce leverage, and improve its distribution coverage ratio. The company completed that second one earlier this year when it closed the acquisition of Martin Transport for $135 million. It paid an attractive price of around nine times cash flow for the business. That will help provide a meaningful boost to cash flow this year.
As things currently stand, Martin Midstream expects to cover its sky-high distribution with cash flow by 1.1 times this year. However, the acquisition of Martin Transport will increase its leverage. Thus, it remains in a tight spot.
Martin Midstream plans to continue addressing its leverage and coverage concerns in 2019. The improvement in oil prices so far this year will certainly help, especially since the company has higher direct exposure to commodity prices than most MLPs. While this hurts the company when they plunge, it helps when prices rebound.
However, that rebound alone won't be enough. The company will need to continue looking for other ways to boost its financial profile, such as selling additional assets and redeploying the cash into higher-returning opportunities. The MLP has already put its Cardinal Gas business up for sale, which could provide a boost depending on what it receives for that asset and how it uses the proceeds. Meanwhile, the company could still slash its enormous distribution. That would be the prudent thing to do since it would quickly improve coverage and reduce leverage as it reallocates cash flow toward debt reduction. That's the path most peers have taken to solve their financial woes.
Not worth the risk
Martin Midstream is trying to improve its financial profile while maintaining its massive distribution. While the company might be able to do both, that seems unlikely, especially since so many other MLPs have slashed their payouts to strengthen their finances. I think that's the likely outcome for Martin Midstream, which is why income seekers should avoid the temptation of its sky-high yield.
