Don't Fall for These 6 Dividend Stocks: Cuts Are Coming

The COVID-19 outbreak is grinding the global economy to a halt. That's causing oil demand to fall off a cliff just when supplies are gushing because of the collapse of a market support agreement between OPEC and Russia. Those dual shockwaves have sent crude oil prices crashing to their lowest levels in decades.

The massive decline in oil is forcing energy companies to take drastic action to stay afloat. Most are cutting capital spending, while others are cutting even deeper by slashing dividend payments. Investors expect more dividend reduction announcements in the coming weeks as companies adjust to these turbulent market conditions. Among those likely to reduce their payouts are financially weaker master limited partnerships (MLPs) that focus on gathering and processing oil and gas.

Image source: Getty Images.

A sign of things to come

Midstream companies Targa Resources (TRGP 0.67%) and DCP Midstream (DCP) were among the first dividend casualties. Targa slashed its payout by 89%, while DCP Midstream reduced its distribution by 50%, which will save these companies $755 million and $325 million, respectively. Both expect to use that money to strengthen their balance sheets by paying off debt. 

Those payout reductions came as no surprise. For starters, as the leading gathering and processing companies in the Permian Basin, they generate a meaningful portion of their income via commodity-based margins, which fluctuate with prices. On top of that, they had junk-rated credit ratings, which makes it more expensive and challenging to borrow money during good market conditions and nearly impossible when they're malfunctioning. Because of those issues, these companies had no choice but to slash their payouts and redirect that cash toward shoring up their financial profiles.

The next dominoes to fall

Several other financially weaker midstream companies with more fluctuation in their cash flows will likely follow their lead in the coming months. Here are the most probable candidates:

Data source: Google Finance. NOTE: Yields as of March 24, 2020.

Those dividend yields aren't misprints. They've risen to such heights because investors fully expect these companies to slash their payouts. CNX Midstream has already announced that it plans to reevaluate its capital allocation opportunities. Among the moves it could make is reducing its distribution and allocating that cash toward debt reduction. or buying back some of its equity securities, which have cratered in value due to the market meltdown. 

EnLink Midstream, meanwhile, has already reduced its capital spending plan by 30% because some of its customers have decreased their activity levels and no longer need that infrastructure. However, given the significant decline in its market value, the company might opt to reduce its payout and redirect that cash toward shoring up its balance sheet or buying back equity. 

Western Midstream has been under a lot of pressure because of its exposure to beleaguered oil giant Occidental Petroleum (OXY 0.82%). That company already slashed its dividend and spending plan to shore up its financial profile. This reduction in its activity level will likely impact Western Midstream's cash flow, which will put pressure on the company to reduce its payout, given its weaker financial profile.

Noble Midstream, Antero Midstream, and Enable Midstream are in similar boats. With their customers reducing their drilling activities, it will impact the volumes flowing through their systems as well as the fees they collect. That will put pressure on their balance sheets, likely forcing them to take actions to shore up their financial profiles, including reducing their sky-high payouts.

Don't bank on these big dividends surviving

Financially weak midstream companies with commodity-price sensitive revenue streams will likely need to cut or suspend their payouts due to the significant downturn in the oil market. For many of these companies, it makes no sense to keep paying big dividends since they could use that cash to buy back some of their bonds at a discount as well as big chunks of their beaten-down equity. Because of that, investors should expect to see more dividend reductions in the oil patch, with the payouts of these midstream companies the most likely ones on the chopping block.