There's a lot to be said at Boardwalk Pipeline (BWP), but let's talk about its distribution. We think pipeline firms are excellent examples of the shortcomings of using a payout ratio - almost all of the MLPs (master limited partnerships) have distribution payout ratios above 1. They are simply different business structures compared to corporations, and using the same mousetrap for everything is a recipe for disaster. However, there is usually one constant when it comes to stock analysis, and that is cash flow. Let's see how well Boardwalk covers its distribution with cash.
Structure of the Oil And Gas Pipeline Industry
Firms in the oil and gas pipeline industry own or operate thousands of miles of pipelines and terminals - assets that are nearly impossible/uneconomical to replicate. Most companies act as a toll road and receive a fee for transporting natural gas, crude oil and other refined products (and generally avoid commodity price risk). Though there is much to like, most constituents operate as master limited partnerships and pay out hefty distributions that can stretch their balance sheets. Additional unit issuance (dilution) has become common, and capital-market dependence is a key risk.
Boardwalk is a midstream master limited partnership that provides transportation and storage of natural gas and liquids. It has a significant portion of revenue backed by long-term contracts with credit-worthy
customers. This offers some stability to cash flow. The company boasts an investment-grade profile and a track record of revenue expansion in a volatile gas price environment. Its sponsor Loews Corp is also well-capitalized. Boardwalk boasts a very large distribution (roughly an 7% annual yield). On a unit basis, its quarterly distribution has advanced from $0.179 in the fourth quarter of 2005 to $0.5325 in the fourth quarter of 2012.
Return on Invested Capital
Boardwalk Pipeline's Dividend
Boardwalk Pipeline's dividend yield is excellent, offering roughly a 7% annual payout at recent price levels. We prefer yields above 3% and don't include firms with yields below 2% in our dividend growth portfolio. So Boardwalk Pipeline fits the bill thus far.
We think the safety of Boardwalk Pipeline's distribution is good (please see our definitions at the bottom of this article). We measure the safety of the dividend in a unique but very straightforward fashion. As many know, earnings can fluctuate in any given year, so using the payout ratio in any given year has some limitations. Plus, companies can often encounter unforeseen charges, which makes earnings an even less-than-predictable measure of the safety of the dividend in any given year. We know that companies won't cut the dividend just because earnings have declined or they had a restructuring charge that put them in the red for the quarter (year). As such, we think that assessing the cash flows of a business allows us to determine whether it has the capacity to continue paying these cash outlays well into the future.
That has led us to develop the forward-looking Valuentum Dividend Cushion. The measure is a ratio that sums the existing cash a company has on hand plus its expected future free cash flows over the next five years and divides that sum by future expected dividends over the same time period. We make some adjustments for MLPs (we add back future equity issuance to the numerator), but the interpretation is the same. Basically, if the score is above 1, the company has the capacity to pay out its expected future dividends. As income investors, however, we'd like to see a score much larger than 1 for a couple of reasons: 1) the higher the ratio, the more "cushion" the company has against unexpected earnings shortfalls, and 2) the higher the ratio, the greater capacity a dividend-payer has in boosting the dividend in the future. For Boardwalk Pipeline, this score is 1.7, revealing that on its current path the firm can cover its future dividends with net cash on hand and future free cash flow (including expected equity issuance) roughly 2 times.
Now on to the potential growth of Boardwalk Pipeline's distribution. As we mentioned above, we think the larger the "cushion" the larger capacity it has to raise the dividend. However, such dividend growth analysis is not complete until after considering management's willingness to increase the dividend. To do so, we evaluate the company's historical dividend track record. If there have been no distribution cuts in 10 years, the company has a nice growth rate, and a nice dividend cushion, its future potential dividend growth would be excellent, which is not the case for Boardwalk Pipeline. We have them rated as having good growth potential as recent rate increases have been relatively small in magnitude.
And because capital preservation is also an important consideration, we assess the risk associated with the potential for capital loss (offering investors a complete picture). In Boardwalk Pipeline's case, we currently think the shares are fairly valued, so the risk of capital loss is medium. If we thought the shares were undervalued, the risk of capital loss would be low. All things considered, we like the potential growth and safety of Boardwalk Pipeline's distribution.