Please ensure Javascript is enabled for purposes of website accessibility

Is This 14% Yield a Dividend Trap or an Unbeatable Buy?

By Matthew DiLallo - Feb 15, 2020 at 4:23PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Noble Midstream Partners has a very different view on the future of its payout than the market.

Units of MLP Noble Midstream Partners (NBLX) have tumbled nearly 40% over the past year, which has pushed the yield on its distribution up to an eye-popping 14%. Investors have bailed on the high-yielding midstream company because they believe it will eventually need to reduce its payout given the risks they see ahead for the company.

Noble Midstream's management team, however, has the complete opposite view. Instead of having to reduce the payout, they believe the MLP can grow it at a 10% annual rate over the next few years.

Here's a look at the bull and bear cases for this big-time yield.

A roll of cash next to a calculator and a sticky note with the word dividends.

Image source: Getty Images.

Why Noble Midstream might be a dividend trap

Noble Midstream ended the year with somewhat troubling financial metrics. During the fourth quarter, it generated $65.3 million in cash, which was enough to cover its distribution by a tight 1.1 times.

Meanwhile, its leverage ratio was 4.2 times debt-to-EBITDA, which was a bit above its long-term target of 3.5 times. At first glance, those numbers suggest the company's payout is on shaky ground, especially since it also needs to continue financing expansion-related investments. 

Another concern with Noble Midstream is that Colorado is one of its two main operating areas. That's an issue because the state might enact stricter drilling regulations, which could make it harder for the company's customers to expand their oil and gas output. That political risk recently led an analyst to downgrade Noble Midstream's stock and slash its price target, since Noble might need to reduce its distribution if the state passes more restrictive drilling regulations. 

Finally, commodity price volatility has caused several of Noble Midstream's customers to pull back on their drilling plans. Because of that, the company recently reduced its 2020 outlook.

It initially expected to produce between $500 million-$560 million of adjusted EBITDA and $325 million-$370 million of distributable cash flow. However, it has since reduced those ranges to $500 million-$540 million and $325 million-$355 million, respectively. The concern is that if oil and gas prices continue falling, Noble's earnings and cash flow might come in below those muted expectations, which would negatively affect its financial metrics.

Why Noble Midstream might be a dividend lover's dream stock

While Noble Midstream's financial metrics weakened toward the end of last year, that's due primarily to the timing of the simplification transaction it completed with its parent Noble Energy (NBL). That deal not only brought all Noble Energy's midstream assets under the MLP's full control, but also eliminated the management fees it used to pay its parent.

To put the impact of timing into perspective, if Noble Midstream had owned the assets it acquired from Noble Energy for the full quarter, then its distribution coverage would have been a more comfortable 1.3 times. 

Because of that, and the growth it has coming down the pipeline, the MLP expects its financial metrics to improve this year. In its view, it will produce enough distributable cash flow to cover its payout by 1.2 to 1.4 times, even after reducing its outlook and accounting for its plan to increase the distribution by 10% this year. At the high end, it would hit its targeted coverage level of more than 1.3 times.

Further, it sees leverage falling to a range of 3.3 to 3.7 times this year, even as it finances its $84 million investment to acquire a stake in the Saddlehorn pipeline and $190 million to $230 million of organic expansions. With leverage expected to end 2020 below its 3.5 times target, Noble believes it will achieve investment-grade credit ratings this year. 

With both distribution coverage and leverage expected to be around its targeted levels, Noble Midstream believes it has plenty of the financial flexibility to continue expanding its footprint. In its view, it can complete enough organic expansions to support 10% annual distribution growth.

Too high risk for income investors

If everything goes according to plan, then Noble Midstream should be able to increase its high-yielding dividend at a 10% annual rate for the next few years. However, the concern is that commodity price volatility, as well as the political risks of operating in Colorado, could affect its forecast.

Those two risks increase the potential that this stock could become a dividend trap, which is why income investors might want to look elsewhere.  

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Noble Midstream Partners LP Stock Quote
Noble Midstream Partners LP
NBLX
Noble Energy, Inc. Stock Quote
Noble Energy, Inc.
NBL

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
379%
 
S&P 500 Returns
123%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/09/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.