Just 45 days ago, BreitBurn Energy Partners (NASDAQOTH:BBEPQ) closed the biggest merger in its history and boosted its distribution by 3.5%. But it announced on Friday that it would slice that payout by 52% as the unrelenting sell-off in oil is forcing the company to reevaluate its plans as it digs in for what continues to be a dramatic turn in the market.
Taking action before things got out of hand
Less than a month ago I wondered whether the company's then-20% yield would soon be toast. I thought the company would not consider a distribution reduction for about six months because it was well hedged and had just raised the payout a few weeks earlier. Boy, was I wrong!
It's obvious that Breitburn management expedited action as it became clear the oil market was not likely to improve over the next few months. It was also becoming quite clear that investors were expecting the distribution to be cut. As shown in this chart, the company's units have been beaten down, sending its yield skyrocketing as investors priced in a deep distribution cut.
While the announced distribution reduction is much deeper than it needed to be, the company isn't taking any chances. It wants to avoid reducing the payout again if oil prices keep dropping.
"Our decision today to reduce our common unit distribution was a difficult one but reflects our outlook for 2015 operating and financial performance measured against the ongoing weakness in commodity prices as well as our focus on financial flexibility throughout the year," CEO Hal Washburn said in a press release.
With the cut, Breitburn Energy Partners' distribution coverage ratio is expected to be a very strong 1.35 times in 2015, which means the company only expects to pay out 65% of its cash flow to investors. The company can use that excess cash to pay down debt, buy back its depressed units, or make acquisitions.
Budget cuts, too
One area where Breitburn won't spend that excess cash is drilling additional wells. The company also reduced its capital expense budget for 2015 from $375 million to $200 million.
"Given the current environment, we have also decided to reduce our 2015 capital budget to approximately $200 million," Washburn said. "This amount is consistent with our maintenance capital requirements and includes only those projects that we believe will deliver attractive returns in the current commodity price environment."
The cut isn't a surprise, as the company's history has shown it will reduce capital spending when times get tough to ensure Breitburn's survival. When the price of oil plunged during the financial crisis, the company slashed its capital budget from $130 million all the way to $19 million. This time, however, the budget cut isn't quite as deep, as the company's asset base can deliver compelling economics at today's commodity prices. That said, if oil prices keep falling it would not be surprising to see the company reduce spending even further to preserve cash.
Breitburn Energy Partners decided it was best to cut its payout now rather than wait to see if the market would improve. This move provides the company with a lot of financial flexibility in 2015, which is an important tool in an uncertain market. The reduction will help ensure the company survives the current turmoil in the market, so it can thrive whenever the market improves.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends BreitBurn Energy Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.