If finding a top dividend stock were as easy as just looking at the yield, we'd all be rich. There are always a bunch of high yielders trading on the stock market -- some at bargain-basement prices!
But just looking at the yield isn't enough for income investors. Sometimes that yield is so high because the share price has fallen. Other times, it's a sign that investors aren't willing to pay a premium price for that yield because the company is a risky bet.
Three big yielders right now in the energy sector include Vermilion Energy (VET -0.25%), Targa Resources (TRGP -0.40%), and Noble Midstream Partners (NBLX). Even better, they're all trading at a discount to their year-ago prices. But let's look a little closer to see if those yields -- and the companies behind them -- are safe enough, or if investors would be better off steering clear.
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Big payout, bigger risks
Canadian oil driller Vermilion Energy is currently sporting a 14.3% yield. That seems insanely high, even for a company that has traditionally offered a generous dividend. Part of the reason it's gotten so high is that its share price has fallen 41.8% over the past year. That's certainly a high yield and a rock-bottom price. Unfortunately for investors, there's a reason for the stock's decline.
Oil prices have been in the doldrums lately. Brent crude and WTI crude -- the primary international and domestic benchmarks, respectively -- have mostly hovered between $50 and $65 per barrel for the past six months. That's not terrible, but it isn't particularly good, either, and oil drillers have been paying the price. For the last few quarters, Vermilion's cash flow hasn't been sufficient to cover both its dividend and capital expenditures.
That leaves the company three options: take on more debt to fund the dividend, issue more shares to raise money, or cut the dividend. Unfortunately, Vermilion's debt load -- at 1.4 times EBITDA -- is already quite substantial for a commodity-dependent business. It's already boosted its outstanding shares by 31.7% over the last three years, and with a depressed share price, that route is more expensive now. The company has a good track record of not cutting its dividend even when coverage is tight, and says it won't do so now, but something's got to give.
Vermilion's situation is clearly very shaky, and most income investors won't be interested given the risks. But for those who want to roll the dice, you won't find a better high dividend/rock-bottom price combo in the sector.
A safer choice
At first glance, the situation of midstream pipeline and terminal operator Targa Resources might seem very similar to Vermilion's. The company has a 9.9% dividend yield and a share price that's fallen 18.5% over the past year. For the past several quarters, its operating cash flow hasn't been enough to cover its capital expenditures, let alone its dividend. It has high debt -- even for the notoriously debt-laden midstream sector -- and has boosted its share count by 28.5% over the last three years.
However, Targa has something Vermilion doesn't: good growth prospects that might allow it to get out of its current situation without trimming its dividend. The Gulf Coast Express pipeline from the red-hot Permian Basin -- in which Targa has a major stake -- went into service at the end of September (in other words, not soon enough to impact its Q3 2019 earnings), while Targa's Grand Prix natural gas liquids pipeline and three gas processing plants came into service midway through the quarter.
Sure enough, cash flow improved slightly in Q3 vs. Q2, and there's reason to believe it will improve further in Q4 and into the coming year as additional projects come on line. Make no mistake: Targa is still a risky play given the uncertainty in the oil and gas markets and its less-than-stellar financials, but it looks to be a safer bet than Vermilion. If the company's projections come to fruition, investors who jump in now may see a big benefit. Investors may also appreciate that Targa's dividend is paid monthly, as opposed to quarterly.
New structure, new reason to invest
In the oil and gas sector, especially juicy yields are often found among master limited partnerships (MLPs). In exchange for preferential tax treatment, these companies are required to pay out most of their cash flow as distributions to unitholders. But even among high-yielding MLPs, Noble Midstream Partners' 12% yield is eye-catching. Also eye-catching is its 35.3% unit price decline over the past year.
Noble Midstream Partners has undergone a huge transformation since it debuted in 2016. At the time, it was little more than a tax-advantaged place for its general partner and sole customer, Noble Energy (NBL), to park some of its pipeline assets. But in November, Noble Midstream Partners announced it was reconfiguring its relationship with its parent. It's agreed to buy all of Noble Energy's midstream assets for $1.6 billion in cash and units.
This simultaneously ties the partnership more tightly to its parent -- Noble will now own a majority stake in Noble Midstream -- and also frees it to grow and manage its midstream asset network in ways that benefit itself and its other customers. With Noble Energy itself carrying a very high debt load of 4.8 times EBITDA, it's crucial for Noble Midstream to become less reliant on a single customer.
Noble Midstream is slowing its plans for distribution growth, which may bother some investors, but with a current 12% yield, it's hard to argue that the payout is suddenly unappetizing.
The bargain bin
Like at your favorite retailer, top-quality merchandise rarely finds its way into the bargain bin unless there's something wrong with it. In the case of Vermilion, the highest yield is also the most risky. For Targa, there's light at the end of the tunnel, but still the potential for derailment. For Noble Midstream Partners, a new structure brings new opportunity, and also new challenges, including concerns about the debt levels of its largest customer and parent, Noble Energy.
Only you can decide how much risk you want in your dividend portfolio, but these three high-yield companies are worth a closer look in part thanks to their rock-bottom prices.
