Any time a company's dividend yield approaches double digits, investors should proceed with caution. That's usually, but not always, a sign that the payout isn't sustainable.
So, with MPLX (NYSE:MPLX) currently yielding 9.8%, it begs the question of whether the master limited partnership (MLP) can continue supporting its dividend. Here's a closer look at the energy company's ability to maintain that big-time yield.
The numbers seem solid
Companies need to produce more than enough free cash flow to cover their dividend. That hasn't been a problem for MPLX. The company generated $1.14 billion of distributable cash flow during the first quarter of 2021. That was enough money to cover its payout by 1.56 times. This level marked an improvement from the prior-year period when MPLX produced $1.08 billion of distributable cash flow, covering its payout by 1.44 times.
Another important factor in dividend stability is having a strong balance sheet. Again, MPLX checks this box. Its leverage ratio has also improved over the past year. Consolidated debt-to-adjusted EBITDA stood at 3.9 at the end of the fourth quarter, down from 4.1 during the year-ago period. That's due to earnings growth over the past year and enabled the MLP to maintain an investment-grade balance sheet.
MPLX's combination of excess cash and balance sheet strength gives it a lot of financial flexibility. The MLP has been able to continue investing in its expansion projects while keeping leverage flat. That has allowed it to return additional cash to shareholders through a unit repurchase program. During the first quarter, MPLX returned more than $900 million in cash to investors via the distribution and $155 million in repurchases.
The company expects to generate even more excess cash in the future as it completes its current slate of expansion projects. It has three major pipelines under construction, each of which it expects to finish by year-end. It's on track to produce free cash after funding its capital program and distribution this year.
So, why the high yield?
As those factors indicate, MPLX has the financial means to maintain its payout. However, with a dividend yield near 10%, investors still seem to have concerns about its long-term sustainability.
The biggest factor that appears to be playing a role here is its relationship with refining giant Marathon Petroleum (NYSE:MPC), which owns a majority stake in the company. Large energy companies like Marathon formed MLPs several years ago to grow their infrastructure businesses. However, investors have soured on MLPs in recent years because of lackluster performance. Several energy companies have taken their affiliated MLPs private in response. Meanwhile, those that remain are considering making a similar move. For example, refining giant Phillips 66 (NYSE:PSX) has reportedly explored the possibility of taking its MLP, Phillips 66 Partners (NYSE:PSXP), private.
Marathon explored its strategic options for MPLX in the past, including completely separating it or buying the rest of the units it didn't own. It ultimately concluded that maintaining the status quo was the best path forward. However, renewed speculation that Marathon might buy out its MLP reemerged late last year.
This uncertain future seems to be weighing on MPLX's unit price, pushing up its yield. If Marathon acquires its MLP, investors will likely receive shares of the refining company in exchange. As a result, they'd see a reduction in their income, given the company's lower dividend yield of 4.3%.
The dividend is safe as long as MPLX remains independent
MPLX generates plenty of stable cash flow to support its high-yielding dividend. On top of that, it has a solid balance sheet, giving it plenty of financial flexibility. With its current expansion program wrapping up later this year, the dividend looks to be in great shape.
However, Marathon Petroleum's presence is casting a shadow over the payout. If the refining giant changes its mind and takes its MLP private, investors would see their income stream shrink. While a buyout is always possible, MPLX can support its big-time dividend, making it an interesting option for those seeking a high-yielding investment.