Units of MLP Crestwood Equity Partners (CEQP) have cratered 60% this year, pushing its dividend yield to an eye-popping 20%. The payout has risen to such heights because the market doesn't believe it's sustainable. Several factors drive that view, including the impact of falling oil prices on its customers and some potential effects from a customer bankruptcy and third-party pipeline shutdown.
However, while the market doesn't believe Crestwood can maintain its sky-high payout, its recent market updates suggest things aren't as bad as they might seem.
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Bending but not breaking
Crestwood initially expected 2020 to be a banner year. The company was wrapping up a three-year, $1 billion expansion program, which it anticipated would fuel high-octane growth this year. Its original guidance had adjusted EBITDA rising to a range of $590 million to $620 million -- up 15% year over year at the midpoint -- putting its leverage ratio within its target level of 3.5 to four times debt-to-EBITDA. Meanwhile, it pegged distributable cash flow (DCF) between $350 million and $380 million -- an increase of nearly 20% at the midpoint -- enough to cover its dividend by a comfortable 1.9 to 2.1 times. That would enable it to retain almost all the money needed to fund its capital budget of $150 million to $200 million.
Unfortunately, oil market conditions quickly deteriorated. That led Crestwood to revise its guidance in early May. It cut its adjusted EBITDA range to between $520 million and $570 million and reduced DCF to between $290 million and $340 million. After factoring in the impact of an acquisition, Crestwood expected leverage to be between 4.25 and 4.75 times debt-to-EBITDA, which is a bit above its target range. The company also reduced its capital spending budget to between $140 million and $160 million to keep leverage from rising even further. Despite those revisions, the MLP remained committed to paying its dividend, if market conditions didn't continue deteriorating.
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Additional headwinds emerge
On a positive note, the oil market has dramatically improved over the past few months. WTI, the main U.S. oil price benchmark, rallied a jaw-dropping 90% during the second quarter, giving many oil producers the confidence to restart idled wells.
However, the initial downturn levied a crushing blow to several producers, including large Crestwood customer Chesapeake Energy, which recently filed for bankruptcy. In addition to restructuring its debt, Chesapeake also wants to eliminate some of its legacy pipeline contracts. That had the market concerned it might try to alter its agreements with Crestwood.
That hasn't been the case so far. Crestwood responded to Chesapeake's filing by reiterating that its assets are integral to the energy company's operations. Chesapeake gets a substantial amount of its revenue from the sale of natural gas and NGLs on acreage supported by the MLP's gathering and processing system. It also noted that Chesapeake had paid all its invoices at the time of the filing and had additional cash flow protection via letters of credit. Furthermore, Crestwood noted that it restructured its contracts with Chesapeake a few years ago to competitive market terms. Thus, Crestwood didn't anticipate the filing to impact its ability to deliver on its revised earnings guidance.
A few days later, the company made similar comments when a judge ordered the Dakota Access pipeline in North Dakota to shut down and empty by Aug. 5. Crestwood's system in the region currently delivers oil to that pipeline. Because of that, the market feared it might face some volume constraints, which would impact its income.
However, Crestwood doesn't believe the shutdown will affect its operations. It noted that its system also connects with two other pipelines in the region, and it can move oil via its COLT Hub, which is on a major rail line.
Meanwhile, the company noted that producers in that region bounced back faster than it initially expected. Crestwood assumed that they'd only produce half their normal volume through July because of lower oil prices. However, its customers had exceeded its initial forecast as they were back to 90% capacity as of early July. Meanwhile, Crestwood anticipates they'll bring back the rest of their volume in the third quarter as they restart their remaining idled wells and resume completing new ones. Because of that, the company has increasing confidence that it can achieve its revised 2020 outlook.
Crestwood's big-time payout might survive
This year's oil market downturn has put some pressure on Crestwood's earnings and cash flow, which impacted its financial metrics, causing concerns about the sustainability of its high-yielding dividend. However, market conditions have improved a bit faster than anticipated. On top of that, the company seems relatively insulated from Chesapeake's bankruptcy and DAPL's shutdown. Because of that, the MLP might still be able to maintain its big-time dividend. Though, as attractive as it might seem, it still looks to be a bit too risky for income-seeking investors right now.
