Source: Enable Midstream Partners.
Thanks to the oil crash, Wall Street is pretty much abandoning all energy stocks, which provides income investors with amazingly undervalued long-term dividend opportunities. However, as always, the risk is that investors might end up investing in seemingly attractive high yields that are too good too be true.
Take, for example, Enable Midstream Partners (ENBL +0.00%), which has been butchered by the market over the past year and now offers one of the highest yields in the midstream MLP industry.
Let's look at this troubled MLP's 2015 results and why 2016 might get even worse to see just why long-term dividend investors should steer clear of this value trap.
Rising volumes, but falling earnings and cash flows
| Metric | 2014 | 2015 | Change |
|---|---|---|---|
| Adjusted EBITDA | $881 million | $801 million | (9.1%) |
| Distributable cash flow (DCF) | $634 million | $538 million | (15.1) |
| Distribution per unit | $1.25 | 1.27 | 1.6% |
| Distribution coverage ratio (DCR) | 1.20 | 1.01 | (15.8) |
Sources: 2015 10-K, Yahoo! Finance.
Despite a year-over-year increase of 14% in both its processing and intrastate transport volumes, Enable Midstream Partners saw substantial decreases in both adjusted EBITDA and distributable cash flow. Since midstream MLPs operate as tollbooth-like businesses, with cash flows supposedly protected by long-term, fixed-fee contracts, what explains this troubling performance?
The answer lies in Enable Midstream Partners' poor contract mix, in which just 81% of gross margin came from fixed-fee contracts, and only 54% of gross margin was protected by minimum volume commitments.
Given that Enable Midstream has direct commodity exposure via its gathering pipelines, which support drilling rigs in Oklahoma's SCOOP and STACK shale formations, falling natural gas prices have resulted in declining gas rig counts, which threaten to cause further volume declines in 2016.
Henry Hub Natural Gas Spot Price data by YCharts
While management guidance was cautiously optimistic about seeing 2016's DCF increase by about 2% or so, as well as its ability to maintain a coverage ratio above 1, I'm skeptical of this outlook, for three reasons.
Payout out profile at first seems appealing, but ...
- Yield: 22.5%
- 2016 coverage guidance: 1.0 or greater
- Analyst five-year annual distribution projections: 0.6%
Management's 2016 DCF assumptions and coverage guidance are predicated on having natural gas and oil prices average higher in 2016 then their current market prices.
In addition, Enable Midstream's gathering pipelines are currently still servicing 32 gas drilling rigs operating in the STACK, SCOOP, and Haynesville shale formations, as well as Western Oklahoma. This means that should gas prices stay low, or fall further in 2016, its customers could cut back on production and decrease the MLP's volumes and cash flows even further.
With its 2015 coverage ratio already balancing on the knife's edge of sustainability, it's no surprise that Wall Street isn't too confident about Enable Midstream's ability to maintain its current distribution in these market conditions, which explains its sky-high yield.
... Credit rating downgrade is another reason to avoid this MLP
The midstream MLP industry is incredibly capital intensive, and to secure its current payout, much less grow it, Enable Midstream Partners needs access to cheap debt and equity financing, since it pays out all of its DCF to fund its current distribution.
Unfortunately, with its unit price in free-fall, access to equity markets is uneconomical, and on Feb. 2, S&P downgraded Enable Midstream's credit rating from "investment grade" to "junk." This means that the MLP's future debt refinancing costs on its $3.1 billion in debt are going to be substantially higher than its current average interest rate of 2.9%.
In fact, to pay off $363 million in debt coming due in 2017 that it owed one of its sponsors, CenterPoint Energy (CNP 1.02%), the MLP recently sold CenterPoint $363 million in preferred equity that pays a 10% yield.
This represents a major problem for Enable Midstream, because its return on invested capital for the past 12 months was already negative-6.34%. This showing indicates that the MLP isn't currently able to grow profitably, and its credit downgrade will mean that its cost of capital will only increase, making it even harder to grow its way to distribution sustainability and growth.
Finally, there's the fact that CenterPoint and OGE Energy Corp. (OGE 0.44%), Enable Midstream's other sponsor and general partner, are a gas and electric utility, respectively. This means that Enable Midstream's growth runway is very limited to begin with, because its sponsors don't have a large amount of midstream assets to drop down to it to fuel the MLP's growth, even if it had access to cheap capital.
Bottom line
Being able to determine which midstream MLPs represent great long-term values and which are currently cheap for a good reason is likely to make the difference between whether long-term income investors can profit from the ongoing energy crash.
With its weak contract mix, dubiously sustainable payout, credit downgrade that's sure to increase its cost of capital, terrible profitability, and short growth runway, Enable Midstream Partners is one high-yield energy investment you should steer clear of.
