Plains All American Q

Plains All American Pipeline Assets. Image from company.

One thing this oil crash has done is prove some midstream MLPs 'business models less resilient than others. One such example is Plains All American Pipeline (NYSE: PAA) and its general partner, Plains GP Holding (NYSE: PAGP). Their most recent earnings results were bad enough to send their respective unit prices down 12% and 19% the next day.

However, long-term investors should be more concerned with two major risk factors these results reveal. Let's take a look at these risks and what it could mean for the future of Plains' dividend.

Brutal results

MetricQ3 2015Q4 2015YOY Change
Revenue  $5.9 billion $11.5 billion   (49%)
Adjusted EBITDA  $497 million $527 million   (6%)
Distributable cash flow (DCF)  $338 million $369 million   (8%)
Quarterly distribution  $0.70  $0.66  6.1%
Distribution coverage ratio (DCR)  0.79  0.99  (20%)

Data source: Plains All American earnings release.

Plains All American Pipeline had a very challenging quarter, especially when it comes to revenue. That situation stemmed from the MLP's Supply and Logistics division, which has the most exposure to crude prices and faced lower oil gathering volumes, as well as falling margins on its commodity trading business.

However, the most concerning thing about Plain's results was the decline in DCF, which is what funds the distribution. Thanks to its 6.1% year-over-year distribution increase this quarter, the DCR contracted severely. This situation suggests All American's distribution isn't sustainable at current rates and potentially at risk of a payout cut in the future. Plains GP Holdings investors would suffer if this happened as well because Plains GP Holdings' only assets are its interest in Plains All American's general-partner stake.

Continuing weak distribution coverage

Plains All American Guidance For Q
Source: Plains All American Pipeline investor presentation.

Management claims that seasonal effects on NGL sales will help boost next quarter's DCR. Plains. Management is guiding for $348 million in cash flow next quarter. For the full year, its coverage ratio would come in at just around 0.87 assuming Plains issues no new equity in the coming quarter. Any way you cut it, based on management's own guidance, Plains All American will probably be starting 2016 with an questionable distribution now that 20% of its adjusted EBITDA is exposed to commodity prices. 

CEO Greg Armstrong says that "PAA has a solid financial position with over $3 billion of liquidity and numerous capital projects scheduled to come on line or ramp up activity levels over the next 18 months that will contribute meaningfully to our cash flow." That statement makes it clear that Plains plans to grow its way out of trouble. But when you examine its ability to do so things look a lot less rosy.  

Risk two: insufficient liquidity to fund growth efforts
Plains All American's $3.1 billion in liquidity consists of three credit revolvers. One of those credit lines, though, is only for its supply and logistics division to buy oil and NGL. Thus, the actual liquidity available to fund growth projects is $1.7 billion. To make matters worse, two of its credit revolvers come with covenants forbidding it from exceeding a debt-to-EBITDA ratio of 5.

Plains All American finished the third quarter with a debt-to-EBITDA ratio of 4.92, which puts it very close to breaching its debt covenants. Any covenant breach would automatically result in a distribution suspension. 

There are two factors that can hopefully prevent such a scenario. The obvious one is to bring some current projects online to boost operational cash flow. According to managment, Plains has $655 million in projects coming online between the second half of 2015 and first half of 2016 that will help grow its EBITDA. Another option is to sell some assets, which is something the company is pursuing. It is currently negotiating with Valero Energy to sell its 50% stake in the Diamond pipeline. 

The company could raise cash through equity, but with units down 39% this year, and yielding nearly 10%, that isn't ideal. New equity would be like kicking the can down the road, though, because it would make future distribution growth harder. 

Bottom line: Relatively dangerous distribution means Plains All American is an MLP to avoid
Given its high debt levels, and the real possibility that oil prices remain low for several years, I think Plains All American's sky-high-yield is well justified. The risk that management will eventually be forced to cut its payout is high enough that, in my opinion, income investors would do better buying lower-yielding but far safer midstream MLPs.

 

Adam Galas has no position in any stocks mentioned, however, he does lead The Grand Adventure dividend project, which recommends Enterprise Products Partners. The Motley Fool has no position in any of the stocks mentioned. 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.