Inergy L.P. (NRGY) is in the process of a complete makeover. After paying out unsustainable dividends for a few years, it radically started to transform itself. Was it a little too radical for investors? Take a look at what has happened to the company this year and what the future might hold. Could this transformation pay off for investors?
Cash Flow Problems & Bogus Distributions
Ron Hiram wrote in a Seeking Alpha article about the ever increasing EPS payout that Inergy was giving and how it could not be sustained. It is one of the best descriptions I have read. The way he describes it, the "distribution cash flow" is not what has funded the distributions the last couple years. This makes the level if increases unsustainable and eventually it would catch up with the company. He goes on to write that NRGY made an announcement at the end of January that:
… management and the board of directors of Inergy are evaluating a reset of the quarterly distribution to a level that is supportable by the cash flow expected to be generated from Inergy's businesses in the near term.
The farce finally caught up with the company, and it witnessed a 23% drop in its value in a day. In a master limited partnership, return of capital can be seen as a tax reduction technique, but when returns of capital come from the depreciation of assets, there is no "real yield" - it is all smoke and mirrors. Inergy's assets were waning to the point it could not continue to maintain the false perception of such prosperity. Down went the stock's value.
How did this all come about? The company has been in the process of giving itself a complete makeover - and it is not a new process. A long time propane distribution company, it has been on the move to exit this business. Since 2008 it has been picking up "midstream" natural gas assets such as storage and processing but also more and more into pipeline. In 2011 it quickly filed for and spun-off part of the assets into a new MLP called Inergy Midstream L.P.
This allowed the company to pay down a third of its debt, and of course, there is no way it could continue to fund earnings growth like it had. It was time to come clean. April 26, 2012, the company declared a quarterly dividend of 37.5 cents - $1.50 per year - a 47% reduction in the distribution.
In this makeover process, it reached an agreement to sell its propane operations to Suburban Propane (SPH) for $1.8 billion. Through a bond swap, Inergy reduced its debt even more and also receives units in suburban worth a quarter controls in the company. If it all goes through the deal should take place in the fall of 2012. When all is said and done, the new dividend rate is lower, but still a respectable 7.9%.
So what does the future hold?
It is quite obvious that Inergy had to do something with itself because it could no longer attract investors by paying out unsustainable dividend levels. But the transition it is making is quite radical for conservative income based investors who look for stability. A lot of new foundation is being built. It needs to make this midstream strategy work while also seeing Suburban succeed. If it can make this happen then shareholders might win big. But this may not be something that is going to come soon. Natural gas prices are going to have to come up to see an overall improvement in what can happen for Inergy.
So what is an investor to do? Well, presently a 7.9% dividend rate is still not bad to take a chance on. Prices are low, but I cannot project at this point whether or not I think they will go up - or when. So I believe investing at this time is more of a risk and chance with a good dividend. It may pay off long term if one is willing to take the risk.