DCP Midstream: Few Reasons Not To Grab This 20% Yield

Summary

• 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.
• I do much more than just articles at The Energy Forum: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

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 - DCP Midstream

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 Assets - DCP Midstream Investor Presentation

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.

Conclusion

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.

Analyst’s Disclosure: I am/we are long DCP. 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.

Comments

[Carlos1874]

The stock price will react but i missed the reduction in the dividend, just .to enticing to reduce it with what may occur over the next few months, it gives them flexibility.

[Carlos1874]

I am very bullish on DCP

[7422981]

I think they are a survivor and I am pretty sure a decent payout is coming given the conditions we have. I thing ENB and PSX want/need a payout given their circumstance, so this is my current favorite in MLPs.

[bearsneedhelp]

The yield is 120%... Still bullish on this one?

[georgefelix75]

-35% something not right in Dodge...

[elliot_mllr]

georgefelix75:
It's now down 46%. Something less right than before. Crude oil just plunged down to a $22 handle. It seems only yesterday that it was $51. The fact that DCP is in the natural gas, not the crude oil business, is irrelevant to the algorithms.
Elliot Miller

[Justanalysis]

Energy Transfer (ET) just affirmed annual 2020 EBITDA guidance and changed the range from $11.1-$11.4b to $11.0-$11.4b. That sure wasn't much. Also, considering delay of $500m of CapEx, which to me, in my opinion, gives a huge amount of cushion for the dividends, both common and preferred.

[7422981]

Insider buying again today(per filing).

[7422981]

Again today insiders are buying into this ridicules sell down(see filings just out).

But if you are wondering why this insanity continues.....

www.zerohedge.com/...

money.cnn.com/...

[Lenore Goldberg]

The CFO bought 16.5K shares.

[nkvbradenton]

These constant buys cannot be just "insider syndrome". We can all clearly see that selling is way overdone. Until we get official statements from the companies, everything is a matter of conjecture. These are the times for some press releases. Isn't it taking too long for some one to come up with a official line? I think so.

[stockinvestor1956]

@nkvbradenton, Sadly... no amount of insider buying or press releases will stem the panic selling of investors who have emotional tendencies. It all has a cascading effect sellers create more selling... and the machine just kick in at certain levels.

But to those who buy at great prices and willing to hold longer term will be richly rewarded over time.

[7422981]

More insider market buying revealed in just released filings.

[Carlos1874]

i believe all of those employees are indicating their opinion about the dividend!!!!! Good luck

[stockinvestor1956]

@Lenore Goldberg, From first look at DCP not over laid the maps but it appears to have similar assets to WES, competitors.

[Lenore Goldberg]

Well, there's a lot of gas to move! I'm not sure they compete, WES is mostly tied to OXY, which owns it.

[flowthrough]

stockinvestor1956, yes WES and DCP do overlap a lot. Note DCP is using a WES plant for some excess capacity. WES stared out as midstream for Apache, then when Apache was purchased by OXY it became an orphan. OXY would love to sell but valuation is too low. Both WES and MPLX have "parent" problems which really impacts value. So if parents do not work over outside investors, or maybe just use a small club and beats them up a little bit, both are bargains.

[7422981]

OXY is still relatively economic in a couple of basins even at ~$30, their problem, of course, is their debt and formerly higher dividend(now cured).

So volumes for WES ought to hold up in the Permian and DJ.
DCP is similarly positioned as far as service areas, so their volumes should not see much deterioration. Most wells in the Permian produce higher ratios' of gas as they mature.

www.zerohedge.com/...

[Carlos1874]

This same exact situation, occurred in 2008, when the price dropped from $45 down to $5.73, i believe was the low. People, including stock brokers and analyst, do not understand that DCP only purchases natural gas, process the natural gas and sell the products to refining companies, particularly P66 who owns an interest in DCP. DCP does not produce natural gas from wells. In effect on 70% of volume they just take a fee for transporting and processing the natural gas. If natural gas is selling for $5mmcf, they take a fee, if the natural gas is at $1.80 mmcf like it is today, they take the same fee, so they have very little risk, yet the price of DCP's stock swings wildly and severely. Why?

Think of it like this, natural gas goes from the well thru DCP's pipeline and measurment of the volume is at the well normally, so title of the gas transfers from the well operator, lets say xyz co., to DCP, so the gas is measured once a month and DCP charges them the fee once a month. Now DCP has control of the inventory as it goes into their processing unit. Lets say worst case, xyz goes bankrupt, the worst case for dcp is they may not get that fee from xyz for one month, maybe at the most approx.45 days. However, DCP hangs on to the inventory or proceeds, until a judge rules where the funds should go. It is in the best interest of both the company and the bankruptcy court for the well to keep producing , so no loss of volume, now DCP in the new month continues to transport and process the gas and directs the funds or inventory to the new entiity being a court or a new company that has purchased the assets. In the new month DCP continues to collect their fee, so risk is pretty minimal at 30 to 45 days.

DCP has very low risk with these new fee basis contracts. They use to utilize a % of proceeds contract where, for example, DCP would pay the operator 80%(estimate) of the proceeds that DCP would receive, but even though, the operator was taking a majority of the risk, DCP was taking some risk on these old contracts. They discontinue those contracts, but some were on specified term contracts which could not be cancelled until some date in the future, but those contracts are rolling off over time as DCP recently indicated that 70% of the contracts were on fee vs the old contracts and they also have hedged some of the remaining 30% so they were exposed approx 20% to start the new year in 2020. DCP is just like Enterprise or Kinder Morgan, fee based or hedged with one big exception which benefits DCP, and its unit holders possibly and that is two Fortune 100 Companies, Enbridge and Phillips 66 own 57% of DCP's stock, so in my opinion DCP is an excellent opportunity at this level with very little risk. The risk of course is yours if you buy, but i was buying all day today. Tomorrow may even be better.

For some reason, the stockbrokers and Wall Street brokerage houses, do not understand the minimal amount of risk DCP has in its day to day business..

The new risk, that everyone seems to want to throw at energy companies is the climate control problem. I cannot tell myself if this is a real threat for natural gas, however, i do believe you are seeing the exodus of coal from the picture and natural gas has replaced most of what was lost from coal. Crude oil could be impacted due to new electric cars , which requires electrical generation with solar and wind power that is supplanting that loss of from crude oil. The predictions i am reading say that wind and solar, will replace the future losses from coal and oil and assuming nuclear is discontinued as it ages. At these prices for natural gas at $1.75 mmcf, solar and wind cannot compete with natural gas at this level, so i think, natural gas is going to around for a long time. You have to remember, natural gas is utilized to produce chemicals and there are approx 70,000 different products that chemicals are found in so the diversity of chemicals tend to support the idea that natural gas will be around for quite some time. Others may disagree and that is their privilege.

If you noticed on ChevronPhillips website, they are planning to build a new world class chemical units in the Corpus Christi area, and this just supports DCP that much more as ChevronPhillips will need natural gas/ngl liquids/ethylene to feed those new chemical units.

[pmalter0]

Excellent comment, as always. I continue to be amazed at the market's inability to distinguish between oil, natural gas, and natural gas liquids. Oil fell yesterday, so DCP fell an additional 40%. but, DCP is not in the oil business, it is not even in the natural gas business, it is a natural gas liquids midstream. Oil fell yesterday, but natural gas liquids rose; so all I can say (and do) is buy, buy, buy.

[Lenore Goldberg]

But . . . the company says they do commodity price sensitivity. Per their presentation:

Oil - $3M per dollar move, price assumed to be $60 (hah!)
Gas - $8M per ten cents, price assumed to be $2.40
NGL - $3M per cent, price assumed to be $.48

The risk I see is that the $3.12 distribution was too high in modern MLP terms anyway, in this environment it's absurd. I'm working with a $2 assumption in my decisions. Seems like one the midstreams most primed for a cut.

[User 538666]

@Carlos1874
Excellent comment; however, a macro environment overrides the fundamentals!?

[Paultown]

Damn, you must really like DCP now. 45%+ yield! Halve the distribution today and we’re still in the 20% yield you state in your article title! Back up the truck?

[georgefelix75]

@Paultown They halved it to 40% currently. They can cut again to 20%

[Carlos1874]

Currently , Enbridge and Phillips 66 each own 28.5% or total of 57% and between the two control the Board, so literally both managements are intimately involved in the management process and overseeing the budget prices for the year. It was a bad call not to go back to their board to submit more reasonable price estimates pofr the year, but typically you do not have these type of swings. Howver, if you look at the Guidance, the the difference in pricing on nat gas for example started at $2.40 mmcf and unit price adjustment was $8 MM for every $.10 adjustment in pricing, but if you look closely, the adjustment is based on whatever hedged priced they already had entered into so we know the full effect then is not going ot be the $8 MM per $.10 unit, so it will be less than that..

You notice they do not mention any guidance on expenses and they lowered employee costs by 15% in 2019 and i believe that number is going to be significant again in 2020, so they already have some help in the offsets to the employees , and i am sure there will be other improvements, such as renegotiating on the Fee base pricing, so by the end the year it likely will be 75% fee based income. I am a big believer in this management and i think over the next five years, that an investment over the next week will make you a lot of money into the future.

[dmitry alph]

Feel like the article was written by a robot. Repeated many times "There’s few reasons not to grab this 20% yield"

[Diamond-Hands]

@dmitry alph wrote:

"Feel like the article was written by a robot. Repeated many times "There’s few reasons not to grab this 20% yield""

The article also used the phrase "exciting to see" no less than four times.

[Gilariverman]

Good article.

[funnymoney123]

Thanks TVP

[carlson73]

I own EPD, MMP, MPLX and ENB, despite thinking I had shown good price discipline while buying these companies, EPD and MMP are the only ones in the black. With all of the investment the midstream companies have been making over the last couple of years, is the demand for NG actually there to get the returns they predict? My understanding is the major North American gas exporters have been having a hard time getting long term contracts to sell LNG to overseas customers. If that is true, that raises a question about whether the demand is there over the next 3-4 years for all of the capacity coming on stream. I would be very interested if anyone has any data providing insight to support the demand projections supporting these investments.
I also have a hard time with companies "moving to a self-funding model" with an indefinite time line. Given the state of the demand for energy, conserving capital for a midstream provider at the moment would seem like a more important strategic issue than having the most capacity on all but the most critical routes. Some of these guys, ET especially, seem very easily distracted by the next opportunity to lay pipe, and asset allocation seems to conveniently slide down the priority list when they see a chance to make strategic investments.
Exxon is a far from perfect company, but the one thing they have demonstrated for decades is that they understand there are probably multiple chances to add important assets, (either when they are built if the market price level is favorable, or when the original builders have to sell them due to liquidity issues) and that liquidity, for a commodity company, is the biggest long term difference maker.

[stockinvestor1956]

@carlson73, Is EPD and MMP still in the green now?

[elliot_mllr]

What price for natural gas is the basis for the projections? That is a crucial question in determining the reasonability of the projections.
Elliot Miller

[georgefelix75]

It would appear the market doesn't believe they will attain those projected results for 2020 and beyond that may be challenging but still 20% leaves some wiggle room and if they are successful then one heck of an investment longer term for income investors....Whats a little scary is the bottom is at $5.75 and not much support from this level....

[Ishcabible 2]

Just picked some up in pre market at 14.50! First bought it in 2008. I have no idea why it is trading so low.

[philduke65]

The LP's offer great dividend yields. If I buy some in my existing ROTH, I believe all the gain and dividends etc. will eventually come out tax free...…….Right???..... Help me here!!

[Steve Rasher]

@philduke65 Although that is true, you have to watch out for unrelated business income, which if it exceeds $1000 in an IRA, Roth and traditional, then you could suffer being assessed unrelated business income tax, UBIT. Looking at my K-1 for $DCP I see a fair amount of UBI, and that is why I hold it only in a taxable account where there are no taxes because of UBI. Steve

[flowthrough]

MLPs in IRAs, Roth or otherwise creates some very complex tax issues. When you sell, the recapture/capital gain may be reported as UBIT. So prior to your sale of the MLP interest the UBIT may noot be that bad, on sale it could be.