Pictured: The circular flow of unsubstantiated support that continues to unravel, previously supporting the prices of the MLP universe. Image published June 18, 2015. © Valuentum Securities. The image above was taken from Valuentum’s President Brian Nelson’s article published on valuentum.com/ June 18.
Forward-looking, cash-flow based dividend analysis has proven its worth once again.
Shipping giant Teekay LNG Partners (TGP) made a tidal wave in its stock recently, knocking income investors over, after it cut its distribution by 80% December 17 in order to fund capital requirements on its future growth projects, reduce debt, and eliminate its need to access equity capital markets in the near term.
The Valuentum thesis on MLPs continues to suggest that distributions related to the business model continue to be fueled by external capital market assistance; this circular flow of unsubstantiated support is evaporating, in our view. We fear there are many more shoes to drop, and we point to the Energy Transfer empire (ETE/ETP) and Plains All American (PAA) as next in line, among the more heavily-followed pipeline MLPs.
Prior to the cut at Teekay LNG Partners, the entity registered a capital-market supported 0.9 adjusted Dividend Cushion ratio or a dividend safety rating of POOR (please note that Teekay registered a POOR rating even with our expectations for capital-market assistance). Without such benign adjustments, we expect the company’s Dividend Cushion ratio to be -3.9 after factoring in the distribution cut. We continue to believe that the unadjusted Dividend Cushion ratio is an efficacious measure of a firm’s true distribution/dividend risk, as it omits help from the external capital markets.
Here’s how we felt about Teekay LNG Partners, “Don’t Be Fooled By Teekay LNG’s Yield,” in November:
…we are not particularly fond of its dividend, no matter how high the yield. Long-term debt of nearly $2 billion and sizeable capital requirements are the key reasons we think there are better dividend growth options available on the market. The increased risk of a coming interest rate hike does not benefit the MLP’s dividend prospects, which are dependent on the capital markets.
The Dividend Cushion ratio, coupled with the qualitative assessment of Teekay’s operating environment, put Valuentum members ahead of its distribution cut and the subsequent collapse in its stock price. To emphasize, this distribution cut was not expected, as evidenced by the near-50% slide in the entity’s stock price.
We have been railing against the MLP business model for some time now, hoping to help investors of all types, and it remains our view that MLPs and their outsize yields are in increasing danger, as capital-market assistance dries up. We continue to emphasize that retirees that are dependent on them for income should be cognizant of the myriad risks associated with their business model (not the least of which is the circular flow of unsubstantiated support shown in the image above).
If you are not comfortable holding master limited partnerships (MLPs) in your portfolio, please contact your financial advisor.
On an unrelated note, but relevant as it relates to the Dividend Cushion methodology, Joy Global (JOY) also recently slashed its dividend, and the Dividend Cushion ratio appropriately warned members in advance of the risk, too. The firm registered a 0.2 Dividend Cushion ratio, or a dividend safety rating of VERY POOR.
The weak operating environment in the mining sector has been no secret, and as a manufacturer of mining equipment, Joy Global is dependent on the spending of mining companies. The firm reported that its customer capital expenditures were down ~18% in its fiscal 2015, which ended October 31.
The dividend cut followed the company’s reporting of a net loss of $12.02 per diluted share in fiscal 2015. Full-year bookings fell 25% on a year-over-year basis, giving little hope for a near-term improvement. In this context, the dividend cut makes sense as it relates to the health of the company as it struggles through this downturn in the end market it serves.
For those still getting familiar with our unique financial analysis, the Dividend Cushion ratio considers the firm’s net cash on its balance sheet (cash less debt) and adds that to its forecasted future free cash flows (cash from operations less capital expenditures) and divides that sum by the firm’s future expected cash dividend payments over a discrete five-year period. All of this data and analysis is homegrown at Valuentum.
At its core, the Dividend Cushion ratio tells retirees whether the prized stock in their income portfolio has enough free cash flow to pay out its dividends in the future, in our view, while considering its debt load. If an entity has a Dividend Cushion ratio above 1, it has the flexibility to cover its dividend, in our view, but if it falls below 1, trouble may be on the horizon. This was the case for Teekay LNG Partners and Joy Global.
As always, please do keep monitoring the Dividend Cushion ratios of companies in your portfolio, especially if you’re dependent on them for income. We expect to update our 16-page valuation reports and dividend reports on Joy Global and Teekay LNG Partners soon.
Pipelines – Oil & Gas: BPL, BWP, DPM, ENB, EPD, ETP, EVEP, HEP, KMI, MMP, NS, PAA, SE, SEP, WES
Image Sources: Roy Luck, Simon Cunningham, Images Money, Trading View. No alteration has been performed on the pictures.