This 16.6%-Yielding Energy Dividend Is on a Surprisingly Solid Foundation

Conditions in the oil market were abysmal during the second quarter. Demand collapsed, causing prices to crater, which forced many oil producers to turn off some of their pumps.

However, while this harsh environment affected many energy companies, it didn't have much impact on master limited partnership Crestwood Midstream Partners (CEQP). Its eye-popping 16.6%-yielding distribution appears to be on solid ground.

A look at the numbers

Data source: Crestwood Equity Partners. 

Crestwood Equity Partners delivered better-than-expected results during the second quarter, thanks to recently completed expansion projects and the strength of its diversified business model:

Data source: Crestwood Equity Partners. Chart by the author.

Earnings from the company's gathering and processing activities dipped 1.8%, primarily because of production curtailments as a result of lower oil prices. However, recent expansion project completions muted much of this impact. For example, processing volumes in the Bakken soared 148% year over year thanks to the completion of the Bear Den II plant last August. Crestwood also benefited from improving market conditions during the second half of the quarter as oil prices recovered, enabling producers to restart shut-in wells quickly. That means volumes exceeded the company's base case forecast during the quarter.

Storage and transportation earnings rose by about 3%, fueled by higher volumes on the company's Stagecoach joint venture. That more than offset lower rail loading volumes at its COLT Hub because of lower oil prices.

Earnings from marketing, supply, and logistics activities soared 45.1% during the quarter. The main driver was Crestwood's natural gas liquids (NGLs) logistics business, which took advantage of low prices in the quarter to build an inventory at its newly acquired storage assets.

Image source: Getty Images.

A look at what's ahead

"Looking to the second half of 2020, we have increasing confidence in our ability to deliver the mid-to-upper range of our revised annual guidance based on several factors including lower shut-in production on our oil-weighted systems, the resumption of completion activities of the DUC [drilled but uncompleted] inventory on the Bakken Arrow system, and higher operating margins across our portfolio due to significantly reduced O&M and G&A costs," stated CEO Robert Phillips. That updated guidance range has adjusted EBITDA coming in between $520 million and $570 million and distributable cash flow of $290 million to $340 million.

That's enough cash to cover the company's distribution and its remaining capital spending, which will be minimal during the second half because Crestwood has completed all its major capital projects. Thus, the company expects to start generating substantial free cash flow in the coming quarters. That will give it the funds to reduce debt, which should push its leverage ratio down from its current level of 4.2 times debt-to-EBITDA to its target of less than 4.0 over the next 12 to 18 months.

However, two potential headwinds could impact the company's results. First, one of its large customers, Chesapeake Energy, recently declared bankruptcy. Crestwood doesn't expect any impact as Chesapeake is current on its bills and isn't seeking to reject Crestwood's midstream contracts, though that could change.

Another possible issue is a court-ordered shutdown of the Dakota Access Pipeline. If this pipeline does shut, producers in the region will need to find other ways to get their oil to market or curtail production. If they shut in wells, that could affect Crestwood's gathering and processing volumes in the region. However, the company might also benefit from a pipeline shutdown, as it could use its COLT Hub to ship oil by rail.

Nowhere near as bad as everyone feared

The market thought that Crestwood's results would suffer this year as producers shut in volumes because of lower prices. However, oil prices rebounded faster than expected, allowing producers to restart shut-in wells quickly, meaning Crestwood delivered stronger-than-expected results during the second quarter. With the worst seemingly in the rearview mirror, Crestwood is on track to start generating free cash after paying its big-time dividend and funding its growth, which will put its payout on an even firmer foundation over the longer term.