- DCP Midstream has an impressive portfolio of assets as it moves towards both growth and an increase in its fee-based cash flow.
- The company is moving towards a self-funding model, where it can securely cover sustaining capital and its 20% yield.
- DCP Midstream, assuming management continues to execute on its goals, is a strong long-term investment.
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DCP Midstream (NYSE: DCP) is a midstream company with a near $3.2 billion market capitalization and a yield more than 20%. The company’s share price has been punished more than most as a result of COVID-19 fears, however, midstream companies across the board have done poorly. However, as we’ll see throughout this article, this dividend is covered and should continue being paid out.
DCP Midstream Asset Portfolio
DCP Midstream has an impressive portfolio of midstream assets that help to provide secure cash flow for the company.
DCP Midstream is one of the largest natural gas transporters and gathering and processing companies in the United States. The company has spent the last few years rapidly transitioning from gathering and processing to transportation, focusing on the reliability of the resulting cash flow. As a result, the company has shifted from 40% fee-based cash flow in 2015 to 70% in 2020.
I expect that number to continue increasing going forward. As it continues to increase, the company’s dividends become increasingly reliable. More importantly, new midstream assets have synergies with the company’s gathering and processing items, maximizing cash flow. Lastly, the company is focused on additional new midstream assets in growth segments.
DCP Midstream Additions - DCP Midstream Investor Presentation
DCP Midstream is adding 525 million cubic feet / day in gathering and processing infrastructure along with significant NGL takeaway. This gathers the natural gas from the fields in Wyoming and moves it towards population centers and major export infrastructure on the Texas Coast. The company is utilizing expansions here to increase capacity and fee-based cash flow on known routes.
It’s also worth noting that unlikely oil or coal, natural gas demand is anticipated to increase going forward. This is especially true as export infrastructure along the Gulf coast grows. This will enable the company to gather multi-decade secure cash flow. As the company increases midstream infrastructure here, it will connect well to the company’s rapid plans to increase infrastructure near Texas.
DCP Midstream Permian - DCP Midstream Investor Presentation
The above slide indicates the company’s rapid plans to expand Permian Basin infrastructure. The company has also focused on rapidly increasing cash flows from major pipelines here, with 10-15 year commitments. The fortunate benefits of Gulf coast infrastructure is it can connect to numerous other company’s assets throughout Texas maximizing value.
The Gulf Coast Express is another major pipeline that’s helping to solve a major Permian Basin problem - a lack of takeaway capacity. The massive 42” intrastate 500 mile pipeline is moving gas to various takeaway points. The Gulf Coast Express pipeline has other major investors, such as Kinder Morgan (NYSE: KMI), indicating the majors believe it’s a strong investment opportunity.
DCP Midstream Asset Portfolio Returns
DCP Midstream’s impressive asset portfolio will generate significant future shareholder returns, as the company invests. However, with its current dividend of more than 20%, utilizing this cash to repurchase shares versus capital expenditures could generate much stronger returns.
DCP Midstream Gathering & Processing - DCP Midstream Investor Presentation
DCP Midstream has a number of capital significant projects for an almost $3.2 billion company that can generate increasing cash flow. The company’s Gathering & Processing assets are expected to come online through late-2019 to mid-2020. The total capital spending across these projects is ~$535 million. This means ~16% of the company’s market capitalization in new projects is coming online.
DCP Midstream Logistics - DCP Midstream Investor Presentation
On top of this DCP Midstream has a number of logistics assets coming online, including the Gulf Coast Express which came online recently. The company has $1.08 billion in projects expected to come online from the 2019-2020 time period including a massive $575 million of projects starting up in 2020 (just over half of this total capital spending).
This $1.08 billion in spending is primarily based on the company’s partial stakes in a number of quality assets along with the majors, which is exciting to see. The company’s total $1.6 billion in projects expected to start up from 2019-2020 is equivalent to roughly half of the company’s market capitalization. That should be able to result in a near-double-digit increase in cash flow.
DCP Midstream Self-Funding Model
The company’s significant portfolio of assets and potential returns place the company well on the path to achieving a self-funding model with its 20% dividend.
DCP Midstream Self-Funding - DCP Midstream Investor Presentation
DCP Midstream has been proceeding rapidly to a self-funding model, something that allows the company all of its growth without utilizing debt or preferential equity. The company expects to achieve this by 2021, mainly due to a rapid decline in capital spending. That’s exciting to see, the company isn’t skimping out on capital spending, from 2018-2019 it spent ~30% of its market capitalization annually on growth.
By 2021, that is expected to decline to ~$250 million with ~$100 million in sustaining capital. That means that the company is still spending ~5% of its annual market cap on growth, a respectable amount. This is the conclusion of an organic build cycle for the company equivalent to its current market capitalization. It’s worth noting that all this growth supports the company’s 20% annual dividend, that’s incredibly impressive.
DCP Midstream Financials and 2020 Guidance
Past DCP Midstream’s focus on a self-funding model, the company is also focused on overall financial strength and supporting its guidance.
DCP Midstream Liquidity - DCP Midstream Investor Presentation
DCP Midstream’s fundamental short-term goal, as it moves towards a self-funding model, is covering its expenses and maintaining a strong financial portfolio. The company is especially focused on maintaining its liquidity, the company has $1.2 billion in liquidity and its extended its bank facility to 2024 with $1.4 billion. That means the company has liquidity equivalent to ~40% of its market capitalization.
The company is focused on its leverage with a fairly respectable BB+ S&P credit rating and a stable outlook. The company has had no common equity offerings since March 2015, showing its commitment to shareholder rewards. At the same time, I wouldn’t be issuing shares either if I were planning to support a 20% dividend, that’d be a poor use of capital.
The company’s coverage, which we’ve already discussed, is worth paying attention to. The company has a 1.23x coverage ratio on its dividend, an incredibly strong coverage ratio. At the same time, the company has an excess $100 million in dividend coverage, enough to cover maintenance expenditures. The company could even potentially use this coverage to fund growth.
DCP Midstream 2020 Guidance - DCP Midstream Investor Presentation
Going into 2020, the company’s guidance is exciting to see. The company expects ~$780 million in DCF and $650 million in contributions, with sustaining capital of $100 million and $600 million in growth capital. The company can cover its sustaining capital and contributions, something exciting to see. At the same time, it’ll have about 1% of its market capitalization annually to use for growth.
Throughout this time, the company’s leverage and distribution coverage ratio will remain respectable. It’s worth noting that the company assumes natural gas and crude oil prices well above current levels, so its DCF could actually be lower than previously anticipated.
DCP Midstream Risks
DCP Midstream does have two significant risks worth paying attention to. The first risk is that the company is spending significantly more than it's bringing in when you count its capital spending. While this isn’t maintenance capital, it’s capital spent on growth, and we’re counting a 20% dividend in this, which still means the company needs to access the financial markets.
So far, the company has had a decent time raising debt, its most recent 10-year bond raise was at ~5% (or ~3% above the 10-year yield at the time).
DCP Midstream’s second risk is the chance of difficulties in the midstream markets. The company has 10-15 year contracts on its midstream assets, however, it still earns cash flow that isn’t fee-based. A significant 30% of its cash flow still isn’t fee-based and significant changes in this can hurt the company’s ability to cover dividends. However, the chance of this cash flow fully disappearing is low.
DCP Midstream has an impressive yield of ~20% and there’s few reasons not to buy it. Despite the company’s difficulties, the company currently anticipates a 1.2x dividend coverage in 2020. That impressive dividend coverage means there’s more than enough leftover capital for the company to cover its sustaining capital. There’s not many companies that can cover sustaining capital and a 20% dividend.
On top of this, the company is wrapping up a massive growth spending portfolio. The company plans ~$600 million in growth spending in 2020, a rapid drawdown over the past few years. This is a massive decrease in the company’s growth spending plans, but the recent spending will begin to generate increasing shareholder income. There’s few reasons not to grab this 20% yield.
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