The energy sector has been an absolute disaster over the last year or so. Oil continues to fall to lows not seen in decades. That’s sent stock prices for energy firms plunging as well. The broad sector measure, the Energy Select Sector SPDR ETF (XLE), is down around 39% over the last 52 weeks.
But some energy subsectors have fared much worse. Take master limited partnerships (MLPs), for example: the combination of rising interest rates and falling oil prices have sent them hurtling even lower than the broad energy sector.
And none have dropped like pipeline all-star Plains All-American (PAA ). Fears of dividend cuts are in the air at Plains after the oil rout. However, recent moves by management may just be enough to keep the MLP’s high 14% dividend intact for the rest of the year. Investors looking for a high-yielding bargain might want to consider units.
Several Issues at PAA
The problems for Plains started last summer when a series of accidents occurred at a few of its facilities. Back in May, PAA’s 901 pipeline located in California ruptured and began to leak crude oil onto one of the most biologically diverse coastlines of the West Coast. All in all, around 3,400 barrels worth of crude oil spilled into Santa Barbara’s waterways. Two months later, a pumping station in Illinois failed and spilled another 4,200 gallons of crude oil. While the accidents were nowhere near as bad as BP’s (BP ) Deepwater Horizon spill, they certainly weren’t cheap for the firm to deal with.
PAA was forced to close the 901 pipeline indefinitely as it works to clean up and fix the corrosion issues with the line. Plains estimates that the two spills will cost $262 million to clean and the closure of the line would clip earnings and cash flows by a pretty significant sum over the course of the back half of 2015 and into 2016.
That was strike one.
Meanwhile, as this was going on, crude oil prices were dropping like a stone. That posed another issue for Plains. PAA owns and controls nearly 18,900 miles of crude oil and NGL pipelines and gathering systems as well as 125 million barrels worth of storage facilities. The bulk of that is tied to long term “take or pay” volume-based contracts. However, about a quarter of Plains assets, such as NGL fractionation, is tied to energy commodity prices. And with a dearth and oversupply of certain energy logistics assets, such as tank cars, barges and trailer trucks, cash flows at PAA have dropped hard.
Last quarter, PAA reported that its distributable cash flows ratios was only .78×. Over the trailing twelve months that number was .93×. That basically means that cash flows were only covering about two-thirds of what PAA was paying out as a dividend to its investors.
Under that scenario, PAA wouldn’t be able to keep its payout, let alone grow it aggressively like it has done over the last few years. Investors were expecting a big time cut and units of the MLP fell hard.
A Saving Grace
Well, PAA managed to reaffirm its payout and fund its growth projects through 2017 in a creative way. Plains kept its payout at 70 cents per share and will do so for the rest of the year in order to keep its coverage ratio near 1×.
The second piece to PAA’s plan is that the firm has used creative financing to help it raise money to build out new projects. MLPs are constantly selling units or tapping the debt markets to raise capital to fund the construction on new pipelines and assets. The cash flows from these new builds help pay off the interest expense or pay dividends on the newly issued shares. Unfortunately for Plains, the drop in its share price has left that an expensive proposition, while its credit ratings have taken a hit thanks to the spill.
Instead of reducing its distribution and using that cash to pay for its 2016 CAPEX, PAA decided to issue $1.5 billion in convertible preferred shares with an 8% yield in a private placement. The preferred shares come with a host of beneficial features for Plains, including paid-in-kind kickers and IDR waivers, and it prohibits investors from hedging their PAA exposure. The real beauty is that the issue will allow Plains to fund new projects at cheaper rates than traditional routes. The firm said it wouldn’t need to raise additional funds until 2017.
While the flat dividend for 2016 may be disappointing news to those unit holders who have become accustomed to PAA’s dividend growth, it helps the firm “kick the can” for a bit and avoid a Kinder Morgan-like (KMI ) dividend cut. More importantly, the preferred issue helps provide a way to fund future dividend increases in 2017.
A Balance of Risk and Reward
Plains isn’t without its risks. Nothing yielding in excess of 14% is risk-free. But the recent deal will allow the firm to strengthen its balance sheet, boost liquidity, fund future growth as well as sustain its current dividend rate. It’s exactly what shareholders needed to hear from the beaten down MLP.
Investors looking to buy PAA today can do so at a price-DCF metric of 8. That’s super cheap in the world of MLPs. And with that payout pretty secure, thanks to the new deal, it’s even better considering that Plains yields 14%. Investor’s today just have to get through the year before some of the new projects start kicking in and flowing cash back into PAA’s pockets. That should help up the dividend once again in 2017.