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This 13.7%-Yielding Stock Plans to Keep Increasing Its Dividend in 2020

By Matthew DiLallo - Nov 27, 2019 at 11:05AM

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Western Midstream believes it has plenty of payout fuel left.

Western Midstream ( WES 0.30% ) has quietly put together an excellent dividend track record. The master limited partnership (MLP) has increased its payout in each of the past 27 consecutive quarters. That steady growth has boosted the yield on its distribution to an eye-popping 13.7%.

The concern, however, is that when a dividend yield gets that high, it's often a sign that a reduction is on the way. But that doesn't seem to be the case with Western Midstream's payout. That was one of the clear takeaways from the energy company's third-quarter conference call, as its management team expects to continue growing the payout in 2020.

Progressively taller stacks of coins are lined up to resemble a rising chart, as a hand prepares to place another coin on the tallest stack.

Image source: Getty Images.

We see good things ahead for 2020

Western Midstream's CEO, Michael Ure, provided investors with the company's preliminary outlook for 2020. He stated that "we expect significant year-over-year adjusted EBITDA growth of approximately 10%." He then pointed to several factors that would fuel this growth:

This is a result of our continued focus on our Delaware operations, including six additional saltwater disposal facilities, an additional 30,000 barrels per day train at the North Loving ROTF [regional oil treating facility], further gathering system build out related to Oxy development plans in the Delaware and DJ basins, and a full-year of distributions from our Cactus II equity investment. We also expect continued economic benefit from increased throughput in the DJ Basin once Latham 1 and 2 ramp up during 2019 and 2020. 

The company has several expansion projects that either came online in late 2019 or will start up next year, which will help drive higher volumes across its midstream systems. As those volumes ramp up, they'll boost the company's earnings.

Meanwhile, at the same time its earnings are rising, capital spending should decline. Ure stated that "for 2020, we expect a decrease in total capital between 20% to 30% compared to the $1.35 billion midpoint of our 2019 guidance." One of the drivers here is that the company has largely completed the "the extensive buildout of our Delaware Basin infrastructure over the past three years." Thus, it doesn't need to invest as much money to expand that system.

With earnings rising and capital spending on track to decline, Western Midstream should have more financial flexibility next year.

Pipelines laid out for construction at sunset.

Image source: Getty Images.

The fuel to keep growing

Ure then turned his attention to how this outlook will affect its high-yielding dividend: "For the past 27 quarters, WES has increased its distribution. We intend and expect to continue quarterly distribution growth, taking into account our goals of lowering leverage and increasing distribution coverage."

While Western Midstream expects to continue its practice of giving investors a raise each quarter, that doesn't mean they can bank on a double-digit boost in 2020. It's also unlikely the company will maintain its current pace, which has it on track to increase its payout by 5% to 6% this year. Instead, the MLP will probably aim for a more moderate growth rate so it can use some of its increased financial flexibility to shore up its financial position.

One reason its yield has risen to such heights is that it has a very tight coverage ratio. During the third quarter, the company generated $304 million in cash, which covered its payout by 1.08 times. That's well below the 1.2 comfort level of most MLPs and less than its targeted level of 1.15 this year. It's therefore likely to grow its payout at a slower rate so it can increase its coverage ratio.

Doing so would also enable it to retain more cash to finance expansion projects, which would help it keep its leverage level down. The company currently has a leverage ratio that's on track to rise to around 4.5 times debt-to-EBITDA next year, a bit on the high side for an MLP. By getting that number down to a range of 3.0 to 4.0, it would put the company in a much stronger position. That's why Western Midstream is also "looking at portfolio optimization as we move forward," according to CFO Michael Pearl, which could include the sale of non-core assets to bolster its balance sheet. These moves to improve its coverage and leverage ratios to more comfortable levels will enhance the long-term sustainability of Western Midstream's high-yield payout.

The risk is almost as high as the yield

Western Midstream fully expects to continue growing its high-yielding payout each quarter next year. That's because its earnings are on track to rise sharply, while its investment spending should come down, which should enhance its financial flexibility. However, its payout is on a less secure foundation these days, given its tighter coverage and higher leverage ratios. That makes it a much riskier option for income-seeking investors.

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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