Calumet Specialty Products Partners fails every major safety test for an MLP. Because of that, there's a very real risk that its distribution could be reduced at some point in the future. ... Investors looking for safety should steer clear of this one. ... -- Matt DiLallo
Five days ago, my Foolish colleague Matt DiLallo penned this warning to investors considering an investment in Calumet Specialty Products Partners (NASDAQ:CLMT) stock. Two days later, Calumet announced it was taking on $400 million in debt to try to keep itself liquid, and suspended payment of its dividend, which had been averaging an annual yield of nearly 27%.
Three days after that -- this morning -- four Wall Street analysts woke up to the fact that Calumet is in trouble, and downgraded the stock.
Oil refiner and master limited partnership (MLP) Calumet has suffered at least four (and counting) downgrades in the wake of its dividend cut. So far, RBC Capital, Janney Capital, and Wells Fargo have all downgraded the company to various flavors of hold, while investment banker Raymond James went one step farther and cut the stock to underperform (aka sell).
And yet, across the spectrum of analysts commenting on Calumet, expectations continue to call for the stock price to rise at Calumet. According to a survey of analyst comments published on TheFly.com, these same analysts who are downgrading Calumet today expect the stock to rise to anywhere from $7 to $10 within a year!
Now here's the question to ask: Given that these analysts were so very wrong about Calumet before, is there any reason to trust their predictions today? To help you answer that question, here are three things you need to know.
Thing No. 1: Calumet's dividend was unsustainable
Wall Street's analysts were taken by surprise when Calumet cut its dividend. They should not have been. As Matt clearly pointed out last week, Calumet's business as an oil refiner "has a lot of variability to it," while the company's dividend (technically, in an MLP, it's called a distribution) commitment was set at a fixed rate. That meant that the dividends Calumet was paying weren't well correlated to how well its business was doing.
Need an example? Prior to suspending its payouts, Calumet had been promising to pay shareholders $2.74 per year in divvies -- but the company had lost $2.05 per share in the preceding 12 months.
Needless to say, it's hard to pay dividends on profits that don't exist.
Thing No. 2: Things are getting worse
Simultaneous with its dividend cut, Calumet gave investors a preview of what's to come in Q1 -- and the news is not good. "Based on preliminary data," warns Calumet, it's going to lose somewhere between $59 million and $83 million in Q1 as "weakness in our fuel products segment" continues to drain away profits.
So no profits this quarter, either.
Thing No. 3: And Calumet could have farther to fall
Calumet shares are down nearly 50% in the first trading day after it slashed its payout. But the company's not out of the woods yet. At last report, the MLP had a market capitalization of just $414 million -- but nearly $1.8 billion in debt, and less than $6 million in cash on hand to pay it.
Last week's announcement of $400 million in new debt issuance will be used primarily to roll over old debt, postponing liquidity concerns for the moment -- but leaving Calumet saddled with a frightening debt burden.
And now, the really important thing
That debt simply has to go away if there's any hope of Calumet surviving as a company, much less resuming paying distributions to its shareholders.
Last year, despite reporting $153 million in losses on its income statement, data from S&P Global Market Intelligence showed Calumet still realizing $162 million in distributable cash flow. With "distributions" now suspended, this cash flow should be available for use in paying down debt. But with $1.8 billion in debt to work through, that's a task that could take a decade or more to accomplish.
The moral of this story: There's not a moment to lose. Now that the dividend has gone the way of the dodo, Calumet must convince shareholders that it's committed to using the freed-up cash the right way: Paying down the debt.