Equitrans Midstream (ETRN 3.22%) and its affiliated master limited partnership EQM Midstream Partners (EQM) currently offer dividend investors jaw-dropping yields of 15.8% and 18.1%, respectively. Usually, when yields rise into the double digits, it's a warning sign that a reduction is on the way.
Both companies, however, recently put out their financial expectations for 2020, which includes maintaining their current payout levels. Here's why they believe they can continue paying such eye-popping dividends next year.
Drilling down into the plan for 2020
Equitrans Midstream's main asset is its ownership stake in EQM Midstream Partners. It therefore uses the cash distributions received from its MLP to pay its dividend.
That's a concern given EQM Midstream Partners' current financial position. During the third quarter, the MLP generated $234.2 million in cash, while paying out $232.5 million in distributions to its investors, including Equitrans. That worked out to a tight coverage ratio of 1.01 times, which is well below the 1.2+ times comfort level of most MLPs. With the company expecting to maintain its current payout level next year, coverage won't improve that much. That's because EQM Midstream only expects its EBITDA to rise to a range of $1.36 billion-$1.41 billion, or about by 3.4% at the mid-point.
Because EQM Midstream will continue paying out nearly everything that comes in to support its high-yielding distribution next year, it still won't retain that much cash to finance expansion projects. That's a concern, given that the company is in the middle of a major expansion phase. It's on track to invest $1.7 billion on expansion projects this year and expects to spend another $1.2 billion to $1.3 billion in 2020.
The company currently plans to bridge that gap by using its credit facility, which had $2.7 billion of available capacity as of the end of September. However, with earnings barely growing and debt rapidly piling up on its balance sheet, its leverage ratio will rise further past its 3.5 to 4.0 times debt-to-EBITDA target range.
Getting over the hump
The reason EQM Midstream doesn't want to cut its payout now is that it expects its earnings to grow significantly in the coming years as its expansion projects come online. The biggest is the Mountain Valley Pipeline, which is a major gas pipeline that it expects will start up by the end of next year. The company owns 47% of the joint venture building the $5.5 billion project, meaning it will earn a sizable portion of its cash flow when it comes online.
In addition to that project, the company has three other notable pipeline expansions under construction that should also start-up in the late 2020 to early 2021 timeframe. In the company's estimation, the $4 billion it will have invested in these projects should generate more than $400 million of annualized EBITDA when they're all in service by 2021. That implies a roughly 30% increase in earnings for the company from its current level.
That upcoming financial boost will enhance the company's distribution coverage while also reducing its leverage ratio. It's why the company is comfortable enough with its financial situation to maintain its big-time payout this year since it will be much easier to sustain once those projects come online.
However, while MVP will move the needle for the company when it comes online, EQM Midstream needs to finish that project without running into any more issues. The company initially expected it would be in service by the end of 2018 and cost $3.5 billion. However, it has encountered several delays, including legal challenges, permit issues, and other work stoppages, which increased its costs. While the company expects the project to be 90% complete by the end of this year, that doesn't mean it will meet its revised in-service date since it could still encounter additional legal challenges.
Way too risky right now
EQM Midstream Partners and Equitrans Midstream plan to maintain their current payout levels while the MLP completes the construction of its expansion projects. That's because they're eventual completion will provide a significant boost to cash flow, which will improve distribution coverage and the leverage ratio. However, if the company runs into another issue with MVP, then it might need to reduce its payout so that it can use some of that cash to begin paying down debt. That's why income-seeking investors might want to steer clear of these high-yield stocks until there's more assurance that these projects will start up as expected.