The energy sector is in the doldrums thanks to COVID-19, with even some of the most reliable segments of the industry feeling the pinch. In recent years Plains All American Pipeline (NASDAQ:PAA) has gotten itself into better fighting shape, which is helping it deal with today's travails. But is that enough to make this midstream partnership and its over-10% yield a buy?
It is rough out there
Earlier in 2020 oil prices plunged below zero. Contemplate that for a moment, since it means that oil producers were, effectively, paying customers to take oil. There were some unique technical reasons for the price decline, and it was temporary, but it is still a massive statement about the supply and demand dislocation caused by the coronavirus pandemic. No segment of the industry has been immune to the impact, driven heavily by the demand decline as countries around the world effectively shut down their economies to slow the spread of COVID-19.
In fact, the pain in the energy sector is likely to linger for some time, since all of the extra oil being produced at the nadir was pushed into storage. So not only does demand have to improve, but the world has to work off the excess oil before energy prices can really mount a sustained rebound. In the meantime, the industry, facing moribund prices, is pulling back hard. This is the backdrop against which midstream entities like Plains All American Pipeline are operating.
To be fair, Plains All American entered 2020 in far better shape than it was just a few years ago. The master limited partnership's financial debt to EBITDA ratio was over six times in 2018. Debt reduction efforts helped to bring that number down to roughly three times at the end of 2019. However, an EBITDA improvement was another important piece of that puzzle. So Plains All American was in better shape than it had been when it was forced to handle today's COVID-19-related headwinds, but in the end that wasn't enough to save the distribution.
Yet another cut
The interesting thing here is that the 50% distribution haircut enacted in May wasn't the first cut at Plains All American in recent years. The shareholder disbursement was trimmed in 2016 and 2017, as well. Although there was an increase in 2019, after the most recent change the distribution is now roughly 75% below its 2017 peak on an annualized basis. The two earlier cuts were meant to help Plains All American get its balance sheet into better shape -- and, as noted above, they were indeed helpful in that regard.
But that wasn't enough to save investors from another cut. The reason for that is pretty simple: The performance of the master limited partnership's supply and logistics business is tied to energy prices. Relatively speaking, this division is small compared to its fee-based pipeline and facilities operations. However, the impact of the oil market downturn in 2020 has been pretty severe.
In the second quarter, volume declines resulted in a 16% drop in adjusted EBITDA in Plains All American's pipeline division. Facilities saw a 1% increase in that number. But supply and logistics suffered an adjusted EBITDA plunge of 99%. Over the first half of 2020 the pipeline group saw a 3% decline in EBITDA, facilities EBITDA was up 8%, and supply and logistics was down by 70%. In 2019 supply and logistics accounted for roughly a quarter of Plains All American's adjusted EBITDA -- no wonder the massive oil price decline resulted in a distribution cut.
Too much risk
Plains All American's third distribution cut in less than five years is expected to result in a distribution coverage ratio of around 2.5 times in 2020. That's pretty robust, but the cuts and the partnership's sensitivity to oil prices have to be kept in mind when you look at the fat 10% yield. There are other midstream players with similarly high yields and much better histories of managing through difficult times, like industry bellwether Enterprise Products Partners. Plains All American just isn't worth the risk for most dividend investors.