Plains All American Pipeline (PAA 2.30%) has a fat 8% distribution yield, which income-focused investors might find attractive. But there's a much bigger story here that you need to wrap your head around before deciding to pull the trigger on buying the stock. And it's not such a good read. Here's what you need to know before you consider buying Plains All American Pipeline.
Relatively speaking
Before digging into the history of Plains All American, it's important to lay out a simple fact. Master limited partnerships are designed to pass income on to unitholders. It's a complex structure with notable tax implications, but the income angle is a key issue to consider for most investors. And while Plains All American's 8% yield is large on an absolute level, it isn't actually that out of line with its peers. For example, midstream sector bellwether Enterprise Products Partners (EPD 0.35%) offers a yield of 7.8%. Conservatively managed Magellan Midstream Partners' (MMP) distribution yield is over 9%.
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Which brings up an interesting fact: Magellan's financial debt-to-equity ratio is around 0.5 times. Enterprise comes in at around 0.7 times on this metric. Plains All American sits at nearly 1.7 times. In fairness, asset writedowns in 2020 are partly responsible for that leverage increase, but it still highlights the importance of Plains All American's balance sheet. If you are looking for a conservatively run energy investment, this probably isn't the right call.
More important, if you are a dividend-focused investor looking for reliable income, Plains All American's history should be a huge warning sign to stay away.
Falling and falling again (and again)
The story here goes back to 2016, which may seem like ancient history given the trials and tribulations of 2020, but it's actually quite important. In October of 2016, Plains All American trimmed its distribution by roughly 20%. It was a difficult time for energy companies to raise capital and the partnership needed to pay down debt. Roughly one year later it trimmed its distribution by another 45%, with paying down debt again part of the reasoning. The distribution was reduced by nearly 60% when you include both reductions.
The problem here isn't that Plains All American needed to shift gears so it could strengthen its business. The problem is that management laid out plans and they didn't pan out. It had to go back to the drawing board and start again. In May of 2019, the partnership increased the distribution by a hefty 20%, suggesting that it had finally gotten back on track. But then 2020 hit and the distribution was cut again, this time by a whopping 50%. Going back to 2016, the distribution has now been reduced by nearly 75%. And the worst part is that debt reduction is, again, part of the logic for the most recent distribution haircut.
MMP Dividend data by YCharts
Although the coronavirus pandemic was a massive headwind and a global economic shutdown would have been virtually impossible to predict, the recurring debt theme with Plains All American is troubling. Note, too, that Enterprise increased its distribution in 2020 and has already hiked it again in 2021. Magellan isn't faring quite as well, but it has held the line on its distribution. The lower leverage profile at each of these partnerships is at least part of the story here.
Trust matters
If you are relying on the income your portfolio generates, then the answer here is pretty simple. Plains All American is not worth buying, despite its high yield. However, even if income isn't your focus, the fact that management has had to rethink its business plans three times over in less than five years should be enough to make you hit the pause button. For most investors, there are simply better alternatives in the midstream space than Plains All American.
