Editors note: In a previous version of this article, the author stated Eagle Rock Energy Partners had an debt to adjusted EBITDA ratio of 22, when the correct ratio is 5.8 times. The Fool regrets this error.
Master limited partnerships bear the expectation that they will never cut their distributions. It's a cardinal sin, but the eight stocks we're looking at today -- including Eagle Rock Energy Partners (UNKNOWN:EROC.DL), CVR Partners (NYSE:UAN), Rentech Nitrogen Partners (UNKNOWN:RNF.DL), and Northern Tier Energy (UNKNOWN:NTI.DL) did it anyway.
First and foremost, the bulk of this list is comprised of variable-rate MLPs, which means the rules of the game change slightly when it comes to distribution increases or decreases. A rough quarter for the nitrogen fertilizer business results in CVR Partners and Rentech cutting their payout. Similar struggles in refining affected Northern Tier Energy and CVR Refining (NYSE:CVRR).
Unlike standard MLPs, the variable rate variety of MLPs do not have a minimum quarterly distribution. That means -- as Alon USA Partners proved this quarter -- that they don't have to pay one at all. Instead, variable-rate MLPs pay out what they can afford to pay out, each and every quarter. Of the 100 or so MLPs on the market today, only nine of them are variable rate.
Eagle Rock Energy Partners, however, is not a variable-rate MLP, and it holds the unfortunate distinction of being the only traditional MLP that cut its distribution this quarter. It is the second time in five years that it has cut its distribution, and management gave us this statement on its quarterly conference call:
While our third quarter results improved as compared to our second quarter, our 2 businesses did not generate sufficient distributable cash flow to fully cover the $0.22 per unit distribution level. Given the low current commodity price environment, our leverage and liquidity position and our view of future commodity prices, our Board of Directors decided to lower the distribution to a level that stabilizes and begins to improve the partnership's leverage ratio and liquidity position.
Now let's compare that statement to the one management issued after it cut the distribution following the first quarter of 2009 (emphasis mine ):
The election by our Board to reduce the distribution will enable us to use our cash flow to enhance our liquidity. Absent any unexpected operational issues or further significant production curtailments in our core areas, we believe we will be able to reduce our leverage or otherwise enhance our liquidity by $75 million to $100 million over the next year. We strongly believe Eagle Rock and its unit holders will benefit from our enhanced liquidity and improved capital structure over the long term.
So much for the long-term benefit. In the short term, cutting its distribution this quarter allowed Eagle Rock to employ 1.05 times payout coverage, and it should be able to maintain this reduced distribution going forward.
The problem is, there is no guarantee that this cut will be any different than the last time. Eagle Rock's total debt outstanding is about $1.4 billion, and its adjusted EBITDA about $238.5 million. At roughly 5.8 times debt to adjusted EBITDA, Eagle Rock is highly levered. The distribution cut is necessary, but it will certainly not be enough to right Eagle Rock's ship.
Regardless, Eagle Rock's place on this particular list reminds us that not all MLP distribution cuts are created the same. Some investors might see opportunity where other investors see exit signs, but due diligence remains important in all cases.