The price of crude oil remains volatile and has driven a
lot of the action in the broader stock market in recent
weeks. We continue our look at high-yielding energy plays
today with three master limited partnerships (MLPs) that
were suggested by readers.
As we look to expand our industry focus to the offshore
drillers and other subsectors in the coming weeks, we
welcome readers to write in and suggest names they want
First, we have received a lot of questions about the
Targa Resources Partners LP (NGLS:Nasdaq) $5.8
billion acquisition of Atlas Pipeline Partners LP
(APL:NYSE). The deal was announced on Oct. 13, which was
during the peak of the sharp sell-off among the MLPs.
Combining the two gathering and processing companies
would create a top-10 midstream MLP. The companies deal
primarily in natural gas and natural gas liquids (NGL)
and will become the second-largest related player in the
While a lot of folks in the investment community were
quick to praise the deal for its potential scale and cash
flow accretion, we see some potential risks to the
combination. For one thing, Targa Resources already had
more than 30% of its business leveraged to commodity
prices, which is at the high end of the range for
By adding Atlas Pipeline’s assets to the mix, the
company’s commodity exposure will actually increase to
about 40%. Earlier this year, management said that Targa
Resources was less hedged less than it had been in the
Shares Targa Resources have dropped about 11% year-to-
date and recently changed hands around $63.80. The
company has a quarterly distribution of $0.78 a share
(4.9% yield), which management has increased 17 straight
While both Targa Resources and Atlas Pipelines have
consistently generated enough cash flow to cover their
respective payouts, we believe that future dividend
growth will be at risk if energy commodity prices
continue to fall.
The combined company will have a stable balance sheet,
but more that, 25% of Targa Resources’ shares outstanding
are held by sector exchange-traded funds. As we noted in
recent bulletins, this exposure can lead to accelerated
declines if redemptions cause forced selling.
With that in mind, we do not believe the stock’s current
yield offers readers enough potential returns to
compensate for the above-average risk.
Second, we will take a look at Kinder Morgan
(KMI:NYSE), which is actually a general partner that has
a few limited partnerships under its umbrella.
Technically speaking, Kinder, which for years had been a
bellwether MLP name, is moving away from the model and
looking to bring its limited partnerships back under one
In a deal, that is expected to close by the end of the
year, the company is looking to combine Kinder Morgan
Energy Partners LP (KMP:NYSE), Kinder Morgan
Management LLC (KMT:NYSE) and El Paso Pipeline
Partners LP (EPB:NYSE) into one C-Corp security.
The company believes this transaction will simplify its
business structure and cut costs, which could lead to
higher dividend payouts. Even though Kinder Morgan will
no longer receive the tax treatment of an MLP, management
will continue to pay out the lion’s share of cash flow as
The company already posted solid quarterly results on
Oct. 15 and Kinder, with nearly $18 billion in its order
backlog, is leveraged to continued demand for energy
pipelines. About 85% of the company’s business is fee-
based and management has hedged about 65% of its
remaining commodity exposure.
Given the company’s solid track record and proposed
strategic changes, the stock has held up better than its
peers in recent weeks. The stock has actually gained
fractionally, month to date, and was recently trading
The company currently pays a dividend of $0.44 a share
(4.5% yield), which has grown steadily over the years.
Investors at the close of trading on Oct. 28 will qualify
for the next payment on Nov. 17.
The new Kinder will maintain a strong balance sheet and
should continue to generate sufficient cash flow to
continue raising the payout in coming quarters. We
believe the stock remains a core holding among the
universe of high-yield energy stocks.
Third, Vanguard Natural Resources LLC (VNR:NYSE)
is an exploration-and-production (E&P) play. The stock
has lost about 7%, month to date, and the shares were
recently changing hands around $25.96.
The company is similar to at Line Energy
(LINE:Nasdaq), which we looked at last week. The E&P MLPs
are generally the most leveraged to commodity prices and
tend to have the highest dividend yields these days.
Vanguard has about 65% to 70% of its production in
natural gas, with the remainder in crude oil and liquids.
The company has hedged about 75% of its production across
all commodities and has boosted its reserves with about
$1.4 billion of acquisitions.
That said, Vanguard has failed to generate enough
distributable cash flow in each of the past three
quarters (during a higher commodity price environment) to
cover its monthly distribution of $0.21 a share (9.7%
yield). Investors at the close of trading on Oct. 29 will
qualify for the company’s next payment on Nov. 14.
While Vanguard is relatively hedged against a continued
decline in energy prices, it struggled to cover the
dividend even when energy commodity prices were higher.
Management has leveraged the balance sheet to make
acquisitions in recent quarters. We believe the business
model would be stressed if energy prices continue to
fall. With that in mind, we believe the stock should be
sold/avoided at current levels.
David S. Peltier
In this issue we offer four earnings reviews, six earnings previews, one company update and two dividend reminders.
Today, we are focusing on large master limited partnerships that are most leveraged to potentially lower energy prices.
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