Crestwood Equity Partners (CEQP) is nearing the end of an ambitious three-year, $1 billion expansion program. That strategy has already started paying dividends, which was evident during the third quarter. The master limited partnership (MLP) delivered smoking growth as earnings surged nearly 40% while its cash flow jumped almost 60% from the prior-year period. That enabled the company to cover its 7.6%-yielding payout by 1.9 times.
That high-octane growth rate should continue throughout most of 2020, while capital spending is on track to sharply decline. As a result, the energy company expects to generate a gusher of free cash flow in the coming year, which was a major topic of conversation on its third-quarter conference call. Here's a look at what management might do with all that money.
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Hitting an inflection point
CEO Bob Phillips discussed the impact of the company's expansion program on the call: "Each dollar invested has followed a very strict criteria to maximize returns, and the big aha here is that from 2017 to 2020 with that billion-dollar net investment, we expect to grow cash flow by over $225 million a year, driven by this expansion program." That big jump in cash flow gives the company more financial flexibility.
One thing Crestwood could do with its growing cash flow is to reinvest it into new expansion opportunities. However, Phillips made it quite clear that this wouldn't be the case in 2020: "So now that we're nearing the completion of the major build-out program, our 2020 capital budget is not insignificant, but as we've been signaling for the last couple of quarters, it's significantly lower than it has been. We're expecting right now to decrease capital spending to a range of $100 million to $150 million a year in 2020, that compares to about $425 million to $475 million in 2019."
In other words, instead of increasing capital spending along with cash flow, Crestwood expects its investment level to decline sharply next year. That's because it will have finished building out its initial midstream systems in the Bakken, Powder River Basin, and Delaware Basin. That frees it up to use its surging excess cash for other things such as paying down debt or returning it to investors.
A glimpse at the 2020 game plan
One of the first things the company plans to do with its excess cash is to get its balance sheet back in tip-top shape. Phillips noted that its debt-to-EBITDA ratio was 4.2 at the end of the third quarter, which is above its 3.5-4.0 target. As such, Crestwood will initially use its free cash to pay off debt so that it can get back into that range. It's "a target we expect to achieve by mid-2020," stated CFO Robert Halpin on the call.
Given that outlook, Crestwood appears as if it will have more than enough financial flexibility to begin returning additional cash to investors above its current distribution next year. CFO Robert Halpin implied as much on the call. He stated that starting in 2020, the company would look at how it can optimize returning cash to investors. It could come "through some form of distribution increase, as well as potentially an opportunistic buyback of units." In other words, the company expects to return more cash to investors next year; it just hasn't yet settled on how much it will increase its payout or if it will allocate some money for repurchases.
Overall, it does seem as if the company will give investors a raise next year. In addition, it appears the company might allocate some funds so it can opportunistically repurchase its common or preferred units. That would give it the flexibility to take advantage of situations that could create more value for investors over the long term.
An exciting year for long-term investors
Crestwood Equity Partners is nearing the end of a significant investment into expanding its midstream system. That has the MLP on track to cash in next year, since capital spending will decline sharply even as cash flow surges. The upcoming gusher of free cash will enable the company to quickly achieve its leverage target while providing it with plenty of excess money to return to investors, who can almost bank on getting a raise next year. That makes Crestwood a compelling income stock to consider buying as we head into 2020.
