In a lot of ways, Williams Companies' (NYSE:WMB) future is up in the air. It's currently in the process of merging with Energy Transfer Equity (NYSE:ETE); however, the market is concerned that the deal might not go through. That uncertainty, when combined with some standalone issues at Williams, makes it a less-than-ideal choice for income investors. Here's what's wrong with Williams, and three better options.
The Williams Companies' red flags
An investor approaching Williams Companies today is facing two potential futures. It could very well close its merger with Energy Transfer Equity and become part of that large energy infrastructure family. There are a lot of positives to that move, including increased diversification, cost savings, and potentially faster dividend growth. But there are negatives as well, including the $6 billion in debt the companies will take on to complete the deal. That debt is a concern, because Williams Companies' credit rating was recently downgraded to BB+, which is below investment grade and is due largely to its outsized exposure to a troubled natural gas producer.
That exposure, whereby that one company supplies nearly 20% of Williams' gathering and processing revenue, is an even greater concern if the Energy Transfer Equity deal were to fall apart, because worries that the customer could go bankrupt if commodity prices don't improve will weigh heavily on Williams. In addition to that risk, over the past year Williams Companies has maintained a 1.01 distribution coverage ratio, meaning that it pays out nearly every penny that comes in. Worse yet, that ratio has been eroding over the course of this year and was just 0.91 last quarter. All this is to say there are better dividend options than Williams Companies, given all its uncertainty and issues.
1. Enterprise Products Partners (NYSE:EPD)
Topping that list, in my opinion, is Enterprise Products Partners. That's because it has the three legs needed to support a solid dividend:
- More than 85% of its gross margin is backed by fee-based contracts.
- Its credit rating of BBB+ is one of the highest credit ratings among MLPs.
- At 1.4, it boasts a very conservative distribution coverage ratio.
In not paying out every penny to investors, Enterprise Products Partners has had cash left over to invest in new projects, which has reduced its reliance on the debt and equity markets. Those new projects have steadily added to its cash flow, which enables it to continue to raise its distribution. If fact, with nearly $6 billion in projects currently under construction and projected to come online in the near term, Enterprise Products Partners expects to grow its distribution by 5.2% in 2016.
2. Magellan Midstream Partners (NYSE:MMP)
In a lot of ways, Magellan Midstream Partners is a mirror image of Enterprise Products Partners, except its main focus is on crude oil and refined products pipelines, while Enterprise Product Partners' focus is on NGLs. Other than that, it, too, maintains a strong BBB+ credit rating, 85% of its gross margin is backed by fee-based contracts, and its current distribution coverage ratio is 1.35. That provides a lot of security for its distribution, while its $1.5 billion project backlog will provide plenty of growth. Add it up, and Magellan Midstream Partners is another solid choice over Williams.
3. Phillips 66 Partners (NYSE:PSXP)
As far as the metrics go, Phillips 66 Partners is very similar to the other two on this list:
- The coverage ratio started last year at 1.14 but was 1.4 last quarter.
- The credit rating is currently BBB.
- Nearly all of its cash flow is derived from long-term fee-based contracts.
The only thing that's different about Phillips 66 Partners is its approach to growth, which is driven almost entirely by drop-down transactions from its parent company. In fact, that parent expects to drop down enough assets through 2018 to drive 30% compound annual distribution growth at Phillips 66 Partners, while it still plans to maintain a coverage ratio above 1.1 and a strong credit rating. That robust growth, when combined with its more conservative financial metrics, makes it a far better choice than Williams.
There's a lot of uncertainty surrounding Williams Companies' future. Not only that, but it's also paying out everything it makes, and its credit rating is weak. That's why income investors might be better off forgetting about Williams and instead take a closer look at Enterprise Products Partners, Magellan Midstream Partners, or Phillips 66 Partners.
Matt DiLallo owns shares of Enterprise Products Partners. The Motley Fool recommends Enterprise Products Partners and Magellan Midstream 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.