Source: Enable Midstream Partners.
In recent weeks, midstream MLP's have been devastated by the oil crash and rising concerns about the security of their distributions. One especially hard-hit pipeline operator is Enable Midstream Partners (ENBL +0.00%), which has seen its shares collapsed b 40% in the past three months and seen its yield surge to an all time high of 14.4%.
With low energy prices potentially stretching for several years, let's look at the four most important factors that will determine whether Enable Midstream's payout survives through 2016 and beyond.
Distribution coverage ratio is most crucial
The decision to continue holding or buy Enable Midstream Partners comes down to one question: Is its distribution sustainable in the long term? The answer will depend on whether the MLP can keep its distribution coverage ratio, or DCR, at or above 1.0.
Over the past three, nine, and 12 months, Enable Midstream has generated a DCR of 1.14, 1.08, and 1.04, respectively.So on paper. the payout is sustainable. However, whether the DCR falls below 1.0 in 2016 is potentially a different story. To understand why, we need to examine the specifics of the MLP's contracts.
Potentially high commodity risk
Source: Enable Midstream investor presentation.
Midstream MLPs are able to pay such high distributions because they operate on a tollbooth business model, with cash flows protected by long-term, fee-based contracts. However, not all such contracts are created equal. With energy prices in freefall, oil and gas producers slashing spending, and production now in decline; firm volume commitments are just as crucial to preserving distributable cash flow, or DCF, and the payout along with it.
Management expects only 53% of the second half of 2015's margin to be protected by such commitments. This means that though technically only 17% of Enable Midstream's margin is tied to commodity prices, in reality the MLP's DCF is still potentially vulnerable, should low energy prices cause customers' production volumes to decline.
What is management doing to decrease this risk? Well, for one thing, it's focusing on locking down additional firm volume contracts. For example, it recently won a firm volume contract to supply a natural gas power plant and local gas distributor with 300,000 MMBTUs per day of natural gas. In addition, Enable Midstream has succeeded in securing over 175,000 MMBTUs per day of gas commitments and is thus moving forward on its Enable Gas Transmission system expansion, scheduled to go online April 1, 2017.
Growth projects are key to offsetting potential falling volume and ...
Possible distribution protection may come from Enable Midstream's general partners CenterPoint Energy (CNP 2.76%), and OGE Energy Corp. (OGE 0.23%). CenterPoint and OGE own 55.4% and 26.3% of Enable Midstream's limited units, respectively, and 40%, and 60% of its incentive distribution rights.Thus, both utilities have large incentives not to cut the distribution if at all possible, as it would greatly reduce the cash flow they receive from their MLP.
The key to protecting Enable Midstream's payout in 2016 is to offset potentially declining commodity prices and volumes through growth projects. To that end, CenterPoint and OGE are planning to bring online $900 million to $1.4 billion in growth projects already contracted for by the end of 2017, with 61% of that spending occurring in 2016. In addition, management is in final negotiations with customers for an additional $600 million to $1 billion in potential expansion projects, half of which would be paid for next year.
Potentially, these growth projects could boost Enable Midstream's DCF by 5% to 24% over the next two years, which might not only be enough to secure the distribution but also allow it to grow. However, be warned that much of the potential DCF growth will occur in 2017, meaning it may not be enough to save the distribution in 2016, should energy prices keep falling or remain at multi-year lows.
... adequate liquidity is key to growth
Funding expansion during an oil crash isn't easy, especially with Enable Midstream's unit price so low that its access to equity markets is essentially gone. Unfortunately for investors, the MLP's balance sheet, though stronger than most midstream MLPs, probably won't give it enough access to debt growth financing to complete its expansion plan. Enable Midstream has a $1.75 billion revolving credit facility, which has $1.3 billion in available borrowing capacity.
However, its debt-to-EBITDA or leverage ratio, when factoring out this quarter's impairment charge, stands at 4.0. Under its debt covenants, Enable Midstream can have a maximum leverage ratio of 5.0, which means that it can borrow only an additional $816 million. Barring a recovery in energy prices in 2016 that would boost the MLP's EBITDA, thus increasing its maximum debt limit, Enable Midstream probably won't be able to fully fund its growth plan.
Bottom line
While at the moment Enable Midstream's distribution looks sustainable, it still has substantial volume risk that could result in a distribution cut next year without a strong and sustained recovery in energy prices. This is something potential investors need to consider when allocating their diversified income portfolios.
