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This Ultra-High-Yield Dividend Stock Is Looking Increasingly Attractive

By Matthew DiLallo - Jul 28, 2019 at 9:19AM

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Tallgrass Energy offers a 10%-yielding dividend and potentially needle-moving growth prospects.

Tallgrass Energy ( TGE ) recently reported its second-quarter financial results. Those numbers confirmed that the midstream oil and gas company's 10%-yielding dividend is in solid shape. That alone should make the company an attractive option for income-seeking investors.

Tallgrass Energy is even more appealing when factoring in its growth prospects. The company has recently completed several expansion-related initiatives that should provide further support for the dividend. Meanwhile, it continued to make progress on three exciting opportunities that could drive needle-moving growth in the coming years.

A jar of coins with the word dividends written on the front.

Image source: Getty Images.

Drilling down into the second quarter

Tallgrass Energy hauled in $204.8 million of cash during the second quarter that it could use to pay dividends. That's enough money to support its current dividend level by a comfortable 1.35 times. This cushion gave Tallgrass Energy the confidence to increase its payout by another 1.9% from its first-quarter level, bringing its total growth over the past year to 8.5%. That marked the company's 16th consecutive quarterly dividend increase.

Supporting that growth has been the improvement in earnings across two of the company's three operating segments. Natural gas transportation led the way in the second quarter as earnings jumped 11.6% from the first quarter thanks primarily to the strong performance of the Rockies Express Pipeline (REX). That system not only benefited from lower interest expenses but also the contribution of a new higher rate contract with a large customer. Tallgrass Energy's crude oil transportation segment, meanwhile, grew earnings 11.1% sequentially thanks mainly to higher volumes on its Pony Express Pipeline. That improvement came even though the company had to shut this pipeline down for eight days in May because of major flooding in Oklahoma.

The lone laggard was Tallgrass' gathering, processing, and terminalling segment where earnings tumbled 20% from the first quarter. That's mainly because the company needed to complete some planned annual maintenance work at two of its sites. Overall, however, Tallgrass' segment earnings rose 8.4% from the first quarter.

A person in a hardhat standing near a stack of pipelines.

Image source: Getty Images.

A look at what's ahead

That growth trend should continue over the next several quarters thanks to the company's progress on expanding its operations. Tallgrass Energy recently placed its Iron Horse Pipeline in service and finished construction on its Grasslands Terminal. The company also completed the acquisition of some water infrastructure assets in the Marcellus and Utica shale region.

Meanwhile, Tallgrass Energy continued to make progress on two other important initiatives: Re-contracting REX and Pony Express and commercializing its large-scale oil infrastructure projects. CEO David Dehaemers stated on the second-quarter call that "we are not yet at the point to share specific details about recontracting or to announce FID (final investment decisions) on our growth and expansion projects." However, he did note that "we continue to make solid progress on all fronts."

He further elaborated on that progress later in the call. He said that the Pony Express Expansion -- which would be part of a joint development with energy infrastructure giant Kinder Morgan ( KMI -0.89% ) -- extended its open season for shippers until the end of July. That would give potential customers more time to sign up for space. He stated that the company's commercial teams are relentlessly working to secure enough customers so that the company can approve this project. Kinder Morgan, likewise, is working on its end to lock up shippers to move more oil out of its Hiland Crude system in the Bakken. This project would feed additional barrels of crude oil into an expanded Pony Express system. While the companies are facing intense competition for these barrels, they're working hard to secure these expansion projects.

In addition to that project, Dehaemers noted that Tallgrass is getting close to approving its Plaquemines liquids terminal, which would export oil from a site along the coast of Louisiana. Tallgrass' CEO said that "we are in discussions with an international exporter that could potentially take enough capacity to move that project forward and to FID."

The only concern with Tallgrass Energy is how it will finance all these projects. The company has a good head start. Not only will Kinder Morgan help fund part of the Pony Express expansion but Tallgrass also lined up a partner for the Seahorse pipeline that would move crude from Pony to Plaquemines. However, it's unclear if it has enough financial flexibility to fund the rest of the projected capital needs. That's because it ended the first quarter with an elevated leverage ratio of 4.7 times debt-to-EBITDA. While that number will come down as its cash flow grows, Tallgrass can't borrow that much money if it wants to maintain a healthy balance sheet. Because of that, the company will likely need to secure more financial partners if it does move forward with these expansions.

An increasingly intriguing income stock

Tallgrass Energy's 10% dividend certainly draws the attention of income-seeking investors. Meanwhile, the company adds to its appeal with its growth prospects. However, there's still lots of uncertainty about whether it can secure its three large oil infrastructure projects as well as how it will finance them. That makes Tallgrass a bit riskier than most other midstream companies. Because of that, investors might want to continue monitoring its progress for a bit longer before buying.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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