Earlier this month, one high-yield MLP called Boardwalk Pipeline Partners (NYSE: BWP) slashed its dividend by 81%.
Overnight, the stock price plunged from $24 to $13. That’s a one-day loss of 46%.
You may not own shares of Boardwalk Pipeline Partners. But the blowup of this Master Limited Partnership (MLP) provides valuable lessons for every income investor. I hope this example can help you protect your capital while achieving your income-investment goals.
Many income investors had been attracted to Boardwalk Pipeline Partners due to the juicy yield. Before the dividend cut, Boardwalk offered investors an attractive 8.5% dividend yield.
In its Feb. 10 press release, the company explained, “The reduction in the distribution will free up internally generated cash to help fund growth and reduce leverage in order to strengthen the balance sheet during the difficult market conditions impacting the Partnership.”
Boardwalk had a terrible quarter. The company’s revenues fell by 4% and cash earnings plummeted by 34%. At the same time, the company’s dividend obligations increased considerably because the share count increased by 17% during the quarter.
This Happens When A MLP Cuts Its Dividend by 80%
Source: Yahoo! Finance
But the real problem for Boardwalk is that its assets are located along the Gulf Coast, where drilling activity and production has been falling due to weak natural gas prices. And that’s hurting the company’s sales and profit margins.
Back in October 2013, I warned Income & Prosperity readers about Boardwalk Partners. Over the past couple of years the heavily indebted company’s cash flow was barely enough to cover its dividend obligations.
I was specifically concerned about the growth prospects for Boardwalk. In The Wealth Building Energy Secret, I wrote, “The company’s revenues and net income are relatively flat over the last three years. Since the business isn’t really growing, Boardwalk hasn’t raised its distributions much…payments to shareholders have increase a total of 10% over the last five years.”
Last quarter, Boardwalk had enough cash flow to cover its existing dividend. But the company’s execs clearly see that the business is in decline, and want to reduce their obligations to shareholders.
The challenges at Boardwalk are simple to understand. For years, the company chose to offer shareholders a healthy 7% – 8% dividend yield. But because nearly all the cash flow was going to investors, there was little investment in growing the business. As a result, even a small 3% drop in revenues was enough to spark a huge dividend cut.
Last week, I recommended shares of two MLPs: MarkWest Energy Partners (NYSE: MWE) and Plains All American Pipeline (NYSE: PAA).
Both of these MLPs are growing their businesses and cash flow. And within the last month, each company again raised its dividend payment.
But the most important metric for every income investor is distribution coverage ratio. This is an easy way to measure a company’s dividend obligations compared with cash flow available for dividend payments (known as distributable cash flow).
For MarkWest Energy Partners and Plains All American Pipeline, this ratio is expected to be 1.2 in 2014. That means that both companies have distributable cash flow that is 20% more than their current dividend obligations. Even if they have a temporary hiccup, they should be able to pay their shareholders.
Both of these MLPs pay a current yield of 4.6%. That may not be enough to get your heart racing. But these safe dividends are far superior to the 3.1% yield from Boardwalk Pipeline.
With healthy growth prospects and sufficient cash flows, MarkWest and Plains All American should continue to reward shareholders.
Income From Pipelines: the Safest Energy Investment
Most investors hope to “catch a flier” on small, risky exploration companies who usually don’t have a drop of oil in their wells. But in our experience, people don’t build pipelines until they know when and how much oil they’ll pump. Which makes pipeline stocks the least risky investments in the entire energy sector. No pipes – no oil. Click here to read my full write-up on two American pipeline stocks paying big (and growing) dividends.