Add Western Midstream Partners (WES -0.50%) to the list of the energy sector's dividend casualties. With crude oil prices continuing to crater, the master limited partnership (MLP) is taking action to preserve cash amid the sector's worsening downturn, including slashing its sizable payout by 50%.

It's another tough break for income investors. The sector, which had treated investors to lavish payouts over the years, has been doing nothing but taking them away this year.   

Scissors cutting a $100 bill in half

Image source: Getty Images.

Writing on the wall

Western Midstream entered this year with high hopes. It anticipated that the expansion projects it finished last year would help boost the volumes flowing through its systems as well as the associated fees. In its view, this growth would fuel a 12% earnings increase this year. That would enable it to cover its payout with cash by 1.25 times. This cushion initially led Western to believe it could boost its distribution by another 1% in 2020. 

However, with energy prices crating, and Western Midstream's main customer Occidental Petroleum (OXY -0.94%) in financial trouble, it caused investors to question that outlook. That led many to abandon Western Midstream, resulting in a more than 70% plunge in its market value. That sell-off pushed the yield on its distribution up to an eye-popping 44%.

That sky-high yield was a sign that the market didn't believe Western could sustain its payout much longer. That self-fulfilling prophecy came to fruition this week as Western slashed its payout by 50%. This reduction ended an era as the MLP had previously given its investors a raise for 28 consecutive quarters. 

Still a bit suspect

In addition to reducing its distribution, Western also cut its capital spending plan by 45% to a range of $450 million-$550 million. The main factor driving that decrease is that producing customers like Occidental have reduced their activity levels this year, which means they won't need Western to build as much new infrastructure capacity. When combined with the distribution decrease, and other expense reductions, these moves will save the company about $1 billion this year. That will enhance its balance sheet and liquidity.

However, what's not yet clear is how much the oil market downturn will affect Western's cash flow. The company has withdrawn its existing guidance and will provide new details when it reports its first-quarter results. The concerns are two-fold. First, given the glut of oil on the market from the impact the COVID-19 outbreak has had on demand, Western's producing customers will likely keep a lid on drilling activities through next year. That could weigh on volumes and earnings. 

Meanwhile, there's a growing risk that a wave of bankruptcies will upend the oil industry, which could affect the fees Western Midstream collects. Occidental Petroleum is in serious financial trouble after it paid a whopping $55 billion to buy Anadarko Petroleum (Western's former owner) last year, financing a large portion of the purchase price with debt. If Occidental goes under, it might ask Western to cut its fees given the massive decline in energy prices.

Because of those concerns, Western warned that it would "reassess future distribution levels," suggesting that it could potentially slash its payout again if market conditions continue deteriorating. The market seems to think another cut could be forthcoming since Western Midstream's yield remains above 20% even though the company slashed its payout.

Still way too risky

Western Midstream took several steps to shore up its financial profile amid a historic downturn in the oil market. While the $1 billion in cash savings will help bolster its balance sheet, it's not yet clear how bad things might get nor how much that will affect Western's operations. Yield-seeking investors should steer clear of Western's still massive payout, since it still doesn't seem sustainable.