DCP Midstream (DCP) makes dividend investors sit up and take notice. That's because the midstream master limited partnership (MLP) currently yields an eye-catching 12.6%.
Here's a closer look at whether that big-time payout makes this company worth buying.
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Drilling down into the numbers
Through the third quarter, DCP Midstream had generated $587 million in distributable cash flow, which was enough money to cover its dividend to investors by 1.27 times. That's a comfortable level for most MLPs, which like to have their coverage above 1.2 times.
DCP Midstream complements its solid payout ratio with a decent balance sheet. While the MLP doesn't have an investment-grade credit rating, it does have a low leverage ratio of four times debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization). That's right at the comfort level of most MLPs.
One concern with DCP Midstream, however, is its direct exposure to commodity prices. Because the MLP focuses on gathering and processing natural gas, a significant portion of its earnings come from percent-of-proceeds contracts and similar agreements that derive their value from commodity prices. In 2019, about 35% of its earnings had direct exposure to commodity prices, though the company used hedging contracts to reduce that to about 22% of the total. The concern is that when commodity prices decline, it will negatively impact DCP Midstream's cash flow.
Growing in the right direction
DCP Midstream has been working to reduce its direct exposure to commodity prices in recent years by focusing on investing in new fee-based expansion projects. The company, for example, is a partner on Kinder Morgan's (KMI -0.40%) recently completed Gulf Coast Express natural gas pipeline. Because Kinder Morgan locked up customers for 100% of the pipeline's capacity under fee-based agreements, it will supply DCP Midstream with very predictable cash flow.
Thanks to Gulf Coast Express and other similar projects, DCP Midstream expects that stable fee-bearing contracts will supply it with about 70% of its earnings in 2020. While that's below the 80%+ target of most MLPs, it's a significant improvement from recent years. Further, after adding in its hedging contracts, the company expects to have 80% of its expected earnings locked in for the coming year.
Meanwhile, the company is working to strengthen its balance sheet by selling non-core assets. Last year, DCP Midstream sold $185 million in assets, which gave it about 35% of the funds needed to support its 2019 expansion program. When combined with the cash it retained after paying its generous distribution, DCP Midstream was able to keep its leverage to a comfortable level. Because of that, the company has the financial flexibility to continue investing in new expansion projects, which will grow its fee-based cash flow over the coming year.
Still a bit too risky for income seekers
DCP Midstream is making all the right moves to put its high-yielding payout on a firmer foundation. However, it still has a bit too much direct exposure to commodity prices for most dividend-focused investors.
On top of that, it hasn't done enough to get its credit rating into investment-grade territory, which would reduce its borrowing costs and increase its financial flexibility. Because of that, it's not an ideal stock for income-focused investors to buy right now, especially when there are so many excellent high-yielding midstream options with even stronger financial metrics.
