Digging Into Buckeye Partners' Distribution

May.20.13 | About: Buckeye Partners (BPL)

Buckeye Partners' (NYSE:BPL) yield is excellent, offering just under 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. Buckeye Partners fits our criteria thus far, but what about the future growth and safety of its distribution? Let's take a look in this article.

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.

Buckeye Partners' Investment Considerations

Buckeye has paid cash distributions since formation in 1986 and boasts an investment-grade credit rating. However, its distribution coverage ratio has waned in recent years (image Source: Buckeye Partners).

The company owns and operates over 6,000 miles of pipeline with roughly 100 delivery locations. We view these assets as difficult to replicate by new entrants.

Buckeye Partners' Return on Invested Capital

Buckeye Partners' Dividend

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We think the safety of Buckeye Partners' distribution is good (please see our definitions at the bottom of this article). We measure the safety of a company's 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. After all, look at Buckeye's payout ratio above - it has been above 1 for years, yet the company has raised its dividend. 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 - adding back cash proceeds from future equity issuance, but the concept 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 Buckeye Partners, this score is 1.5, revealing that on its current path the firm can cover its future dividends with net cash on hand and future free cash flow roughly one and a half times.

Now on to the potential growth of Buckeye Partners' dividend. 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 dividend 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 Buckeye Partners. We have them rated as having good growth potential.

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 Buckeye Partners' case, we currently think the shares are fairly valued, so the risk of capital loss 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 Buckeye Partners' dividend. Still, investors should take note of the firm's deteriorating distributable cash flow coverage trends.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.