4 Energy Partnerships Slashing Their Payouts

It's been a harrowing 18 months for energy sector investors with almost every corner of this important area being under the pump. One such sector hit hard by the current downturn is the publicly traded master limited partnerships group (MLPs), particularly those owning and operating energy infrastructure assets.

The MLP Business Model

MLPs differ from regular stocks in that interests in them are referred to as units and the unitholders (not shareholders) are partners in the business. Importantly, these hybrid entities bring together the tax benefits of a limited partnership with the liquidity of publicly traded securities.

MLPs typically distribute nearly all of their cash flows back to unitholders. They are not required to pay a corporate income tax as the tax liability of the entity is passed on to its owners (or unitholders) in the form of a cash dividend (distribution). This allows the MLPs to offer very attractive yields to the investors.

Finally, the assets that these partnerships own – oil and natural gas pipelines and storage facilities – typically bring in stable fee-based revenues and have limited, if any, direct commodity-price exposure. This enables these MLPs to pay out fairly growing distributions.

Bearish Sentiments Prevailing in the Sector

Considering the potential tax advantages, coupled with their safe and sustainable dividend payouts, MLPs should have been the ‘safe haven investment’ for energy investors during the ongoing oil rout. However, the more than year-long crude price crash has been steadily diminishing the attractiveness of the MLPs on the whole.

In fact, the pipeline companies had a rough 2015 on the stock markets. The Alerian MLP Index – comprising 50 midstream energy firms with 75% of available market capitalization – lost 38% for the year.

Not only has the carnage eliminated years of gains associated with the shale revolution but also wiped out billions in market value from some of the country’s top energy companies.

When commodity prices started their downward journey in the middle of 2014, midstream operators – with relatively consistent and predictable cash flows under long-term contracts – were fairly unscathed. However, with more and more industry participants viewing the oil glut (responsible for the price plunge) as a long-term phenomenon as opposed to a passing trend, the ongoing crisis has eaten into the demand for pipelines and processing plants.

Negative Announcements Galore

Oil sector’s fast deterioration has forced partnerships to make deep cost cuts by reducing/suspending their payouts. Moreover, with units priced at ridiculously high yields for some of them, the partnerships need to maintain a robust cash flow – something improbable in the current environment. Therefore, in an effort to improve their liquidity position, a number of midstream partnerships have resorted to trimming payouts.

Let’s look at four energy partnerships that slashed/suspended their distributions recently:

1.  Kinder Morgan Inc. (KMI - Analyst Report): On Dec 8, the largest pipeline operator in North America slashed its dividend by 75% to 50 cents per share annually. The payout cut by the debt-laden Zacks Rank #3 (Hold) company is likely to free up capital to the tune of $900 million a quarter to fund its expansion capital budget.

2.  Southcross Energy Partners L.P. (SXE - Snapshot Report): In Jan, lower commodity prices forced Southcross Energy Partners to suspend its quarterly cash distributions that amounted to 40 cents per common unit. The Dallas, Texas-based midstream partnership, sporting a Zacks Rank #3, also closed a $14 million unsecured loan. 

3.  Atlas Resource Partners L.P. (ARP - Snapshot Report): Another partnership slashing cash dividend in the wake of collapsing energy prices is Pittsburgh, PA-based Atlas Resource Partners. In Nov, the Zacks Rank #2 (Buy) upstream energy player said that it will chop its annual cash distribution from $1.30 to 15 cents per common unit.

4.  Breitburn Energy Partners LP. (BBEP - Snapshot Report): Trying to shore up its finances in the face of a prolonged oil downturn, Breitburn Energy Partners said it would suspend its common unit distribution. This will enable the Los Angeles-based Zacks Rank #3 oil and gas partnership to save $111 million per year.

Preserving Cash Now = Better Investment Later

The uncertainty of oil prices means that the future direction of the commodity’s movement is anybody's guess. However, fundamentals suggest that the odds are firmly stacked against a sustained rally. Therefore, distribution cuts might actually be a smart move, even at the risk of units being sold off on the announcement.

It might be wise for investors to take a long-term view of the distribution cut announcements rather than get swayed by the short-term pain that it brings. In fact, the suspension/cut in payouts will ensure that more money can be put back into the company, making it stronger, financially healthier, and possibly a better income investment for the future. Finally, it is in the best interests of the shareholders to sacrifice the distribution rather than hang on to one stubbornly that might ultimately prove unsustainable.