Are Top Yields In Energy Preferred Stocks Too High?

Includes: DCP, ET, GLP, NGL, NS
by: Richard Hill

Have you noticed that oil prices and energy related stocks are moving higher?

This article introduces five energy-related companies with 11 preferred stocks that offer some of the highest yields in the marketplace.

I review these companies using the Where’s the Metrics analysis system that analyzes earnings, payout ratios, debt ratios, credit ratings and dividend metrics.

Is it time to add more income producing securities to your portfolio?

The U.S. energy industry has been on fire since fracturing entered the picture, the economy is booming and President Trump has reduced regulations and restrictions on the industry to encourage energy independence. The industry has responded from all positive events by becoming a real powerhouse in the world and are transforming our country from being a net importer of oil and gas to being one of the largest exporters in the world. I have read stories that suggest that we will become the largest exporter of oil in the next few years, surpassing Saudi Arabia and Russia.

For a variety of reasons, oil prices have increased to levels that support growth in the industry. Higher prices result in higher revenue and profits for oil and gas companies. The dark cloud from several terrible years appear to be lifting and forecasts for better times are upon us.

(Chart 1)

As good as the economy is and with the oil and gas markets improving, yields on energy related preferreds are among the highest available in the marketplace. Checking the database at “I Prefer Income”, I found 286 cumulative preferred stocks with an average yield of 7.1%. These 11 preferreds have an average yield of 8.6%. That means these preferreds are 21.1% higher than the overall cumulative preferred average. High yields logically mean that risks are also high. Are these high risks warranted? Are the yields too high?

Introducing the highest yielding energy related preferred stocks in the marketplace

To help answer that question, I am introducing 5 energy related companies with 11 cumulative preferred stocks that are currently among the highest yields available in the marketplace.

I will provide an overall review of these companies by using the Where’s the Metrics analysis system that uses 5 main metrics to help determine the overall financial health of the parent company and their ability to pay a reliable and sustainable distribution. If you have not read about the Where’s the Metrics analysis system, please click on this link to review it. The purpose of this general review is not to give recommendations; but rather, to show areas of strengths and weaknesses from each company. From this review, readers will have a better understanding of the company and able to do further research if warranted.

The 5 metrics that are used to analyze these securities are listed below:

  1. Earnings – GAAP and Non-GAAP
  2. Payout ratios
  3. Debt Ratios
  4. Credit Ratings
  5. Dividend Metrics

The table below contains the 5 parent companies located in the gray rows. Directly under the parent company are their 11 cumulative preferred stocks. There are 27 columns of information, to include general info and financial metrics that are used to obtain a better idea of each of the company’s overall financial health and ability to pay a reliable and sustainable distribution. Each of the 5 areas of metrics are displayed below within the blue rectangles.

(Click on image to enlarge)

(Table 1, 5 energy companies with preferred stocks)

When doing a general review, I am comparing the metrics of the parent company in all areas except credit ratings. My goal is to get a better idea of the overall financial health of the parent because they are responsible for maintaining and paying the distributions on the preferred stocks.

A quick look of the 5 parent companies in gray shows generally fair metrics, with all 3 payout ratios having good scores that suggest they are covering the common and preferred dividends with room to spare. Time to do a review of each stock to obtain more information.

Review of each parent company

DCP Midstream, LP (DCP) is an MLP and midstream energy company with a focus on natural gas and natural gas liquids. They provide many services including gathering, compressing, processing, transporting, storing, and selling natural gas and natural gas liquids. In addition, they also recover, transport, store and sell propane at the wholesale level. They have 2 preferreds stocks (DCP-B and DCP-C) priced a little below $25 with yields at 7.9% and 8%.

Earnings: DCP has a perfect record of profits, with the last 5 years and 5 quarters being profitable on a GAAP basis. Since they also report distributable cash flow (DCF), it is important to compare EPS to DCF. Here is a table to shows both EPS and DCF for the last 5 years and 5 quarters.

(Table 2, DCP, earnings comparison)

It is easy to see that DCF is much higher than EPS over all periods. They have paid the same dividend of .78 per quarter since 2015, so they have covered their common stock dividend with DCF in every period other than 2018Q4. And they just reported their first quarter earnings for 2019 and the DCF was $1.13 for the quarter, higher than all 4 2018 quarters.

Debt ratios: During the Q1 earnings call, the CEO, Wouter van Kempen stated: “We achieved outstanding EBITDA of $326 million and DCF of $224 million, resulting in a distribution coverage ratio of 1.45 times while leverage improved to 3.6 times. Based upon our financial performance and a multi-year strategic transformation of our business model; yesterday, we received the full-term upgrade by Standard & Poor's now putting us just one step away from investment grade.”

I posted this comment because their debt-to-EBTDA ratio is high. Since EBITA has increased, that will help drive the debt ratio lower. The debt-to-equity ratio looks fine at .70.

Credit ratings: The credit ratings are below investment grade, but from his comment, he suggests that the company rating has increased to 1 step from investment grade, so that might be good for the preferred stock ratings.

The final metric is dividends. They have paid a common stock dividend since 2006. Since that time, they have never reduced the dividend, even during the great recession of 2009. It has remained stable at $3.12 per year since 2015. This is why the dividend growth rate is 0. Here is a table of their annual dividends paid since 2006.

(Table 2a, DCP Dividend History)

This table shows ever increasing dividends paid since 2006. The next part of the dividend metric is to compare the current yield to the 10-year median yield of the parent. Since the current yield is much higher than the median, it suggests that investors are still concerned about DCP. If you make the same comparison to all 5 of the companies in this list, the same spread exists with all except for NS.

Energy Transfer LP (ET) is one of the largest midstream companies in the U.S. Their core operations include transportation, storage and terminalling for natural gas, crude oil, NGLs, refined products and liquid natural gas. They have 3 preferred stocks (ETP-C, ETP-D and ETP-E) with prices ranging from $24.18 to $24.80. Yields are approximately 7.7%.

Earnings: ET reports a perfect earnings record with the last 5 years and 5 quarters of profits. All 3 payout ratios are very good and show they are covering both the common and preferred dividend with room to spare. The table below shows the comparison of EPS to DCF.

(Table 3, ET Earnings comparison)

ET has been involved with recent changes in company structure so not all of the past DCF is available. Once again, the information shows a wide difference between EPS and DCF. On top of that, ET just reported Q1 2019 earnings with DCF of $1.6 billion. That converts to .63 per quarter, which is a coverage rate of 2.07%. This is more than 2 times the common stock dividend of .31.

Debt ratios: Debt-to-EBTDA and debt-to-equity are a little high, but not out of balance with the industry.

Credit ratings: The ratings for all 3 are below investment grade, but are the highest rated of all preferreds in the group.

Dividends: I will begin by displaying a table of their dividend history since 2006. This shows that their annual dividend has increased every year, even during the recession of 2009.

(Table 3a, ET Dividend history)

The good news for investors is that they have plenty of room to raise the dividend in the future if they should decide to increase it. The last metric is dividends and the only issue is the spread between the current yield and the 10-year median. This suggests to me that the market is still concerned about ET or the industry or both.

Global Partners LP (GLP) is an MLP and one of the largest independent owners, suppliers and operators of gasoline stations and convenience stores in the northeast area of the U.S.. Having been in business for more than 75 years, Global also owns, controls or has access to one of the largest terminal networks in New England and New York, through which it distributes petroleum products to wholesalers, retailers and commercial customers. GLP has one preferred stock (GLP-A) that is priced at $25.50 and a yield of 9.6%. Even though the price is above par, the yield-to-call is 9.2%.

Earnings: GLP has a good record of earnings with the last 4 out of 5 years and quarters as being profitable.

Payout ratios: GLP uses distributable cash flow (DCF) to determine ability to pay their common dividend. The result is a very respectable .40 common stock payout ratio. Here is a table that shows the comparison between EPS and DCF.

(Table 4, GLP earnings comparison)

The earnings comparison shows the wide difference between EPS and DCF and helps to understand how a company is able to pay the dividend even if EPS may not support it. Besides the common stock dividend payout ratio, the preferred dividend is also very well covered with very low payout ratios.

Debt ratios: All three debt ratios come in with fair ratios.

Credit rating: The rating is NR / NR.

Dividend: GLP has paid a dividend since 2006. They reduced the dividend in 2016, but have since increased it twice in 2019. The last dividend increase was to .51 per quarter, payable 5/15/19. Here is a table of their annual dividends since 2006.

(Table 4a, GLP dividend history)

The last 2 dividend metrics show a spread between current yield and 10-year median which suggests that the market is not appreciating the current condition of GLP or the industry. Nor do they appreciate just how well GLP did during the last recession. The last measurement is dividend growth. They did reduce the dividend in 2016 but have increased it twice in 2019.

NGL Energy Partner, LP (NGL) is an MLP in the midstream sector that provides multiple services including transportation, storage, blending and marketing of crude oil, NGLs, refined products / renewables, and water solutions. NGL has 2 cumulative preferred stocks (NGL-B and NGL-C) with prices of $23.95 and $24.82 with yields of 9.4% and 9.7%.

Earnings: NGL has the worst earnings record of the 5 companies in the list. They have had 2 years out of 5 of profits, but 4 quarters out of 5 of profits. Remember that paying the dividend is not based on EPS but on distributable cash flow (DCF). The table below compares the EPS and DCF. NGL year ends on 3/31. Since they have not reported earnings yet, I cannot provide the information for 2018.

(Table 5, NGL earnings comparison)

Since they have not reported earnings for 2018, not all information is available, therefore the comparison is not as clear cut as the other companies in this list.

Payout ratios: All payout ratios indicate they are covering both the common and preferred dividends. The ratios are good, but they are the worst of the 5.

Debt ratios: All debt ratios are fair. Nothing too far out of line with the industry.

Dividends: NGL has paid a dividend since 2012. They did reduce the dividend 5/2016 and it has been stable since then. Here is a table of their dividend history since 2012.

(Table 5a, NGL dividend history)

The next metric is the spread between current yield of 11.3% and 10-year median yield of 8%. The spread is 2.3 and is the widest spread of all 5 stocks in the list. This suggests that the market has the least confidence in NGL of all the common stocks in the table. But remember, this article is about investing in the preferreds, not the common; although that high yield could represent a good opportunity if one feels that the company is moving forward and the future is brighter than the recent past. The last metric is dividend growth. There is no surprise as we know that they reduced the dividend in 2016.

NuStar Energy LP (NS) is another MLP and one of the largest independent liquids terminal and pipeline operators in the nation. It has operations in the U.S., Mexico, Canada and the Caribbean. Note that on 5/10, a press release states that they are selling the operations in the Caribbean to Prostar and will close in the 2nd quarter. That appears to be good news as the price jumped 7.7% by the end of the day. NuStar currently has more than 9,700 miles of pipeline and 75 terminal and storage facilities that store and distribute crude oil, refined products and specialty liquids. NS has 3 cumulative preferred stocks (NS-A, NS-B and NS-C) with prices ranging from $21.70 to $24.51 and yields from 8.8% to 9.2%. It should also be noted that Y-T-C rates are even higher.

Earnings: NS reports 4 years of profits and 1 year of losses (2018). They also show 2 quarters of profits and 3 quarters of losses. But since the dividend is based on DCF, lets take a look at that info from the table displayed below. Unfortunately, I was not able to obtain previous years of DCF, but I do have the last 4 quarters. The results does show that DCF is much better than EPS.

(Table 6, NS earnings comparison)

Payout ratios: NS has favorable DCF earnings which covers their common stock dividend with a payout ratio of .68. In addition, the preferred stock dividend payout ratios are excellent and cover the preferred dividend as well.

Debt ratios: The 3 debt ratios are not great, but on par with the industry and better than some of the others in this list. Maybe selling the Caribbean operations will help reduce the debt a bit.

Dividend: The good news is that NS has paid a dividend since 2012 and has only reduced it once during those years. That 1 reduction has resulted in the negative dividend growth rate they now have. The one metric that does surprise me a bit is that that there is no real spread between the current yield and the 10-year median yield. Also take note that the common stock yield of 8.4 is the second lowest of all common stocks in the group. Logically this means the market appears to have some faith in NS, at least compared to the group. One last thing that is noteworthy is the fact that NS is only down 2.5% from their 52-week high. On a percentage basis, they are down the least compared to the other 4.

In Summary

The purpose of this article is to introduce 5 energy related companies with 11 cumulative preferred stocks that offer some of the highest yields now available in the preferred stock marketplace. I did a general review using the Where’s the Metrics analysis system that analyzes earnings, payout ratios, debt ratios, credit ratings and dividend metrics. The energy market has gone though some difficult times over the last few years with oil prices dropping to levels that have crippled the industry and has had a negative effect on many companies that are directly or indirectly involved. However, with new technology, less regulations and more demand, oil prices and the industry appear to be recovering.

The 5 companies involved are all midstream companies and have been affected from low oil prices and the downturn in the industry. However, after doing a general analysis, I came away encouraged by what was discovered. All companies have paid continuous dividends, even during the last recession in 2009 and also during the oil crash of 2014 through 2017 when prices dropped from $105 a barrel to below $30. All report distributable cash flows that are high enough to cover the common and preferred stocks.

While debt ratios are not the best, they appear to be somewhat on par with the industry. Yes, they can be improved and if the market continues to grow and improve, there is a good chance those ratios will also improve.

I personally feel that all 5 of these companies have preferreds that offer very generous yields that are amongst the highest available in the market. In fact, based on the analysis shown above, I think the yields may be too high and represent a buying opportunity. Of the 5, I lean towards the preferreds of ET, DCP and GLP; however, the huge yields from NGL and NS preferreds warrant further research.

I hope this article has brought attention to these 5 companies and their preferred stocks and that you may have discovered 1 or more gems that warrant further research. Is it time to add more income producing securities to your portfolio?

Thanks for reading.

Disclosure: I am/we are long DCP.PB, DCP.PC, ETP.PC, ETP.PD, GLP.PA, NGL.PB. 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.

Additional disclosure: This article was written for informational purposes only and is not intended as personal investment advice. Please practice due diligence before investing in any security mentioned in this article.