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Dividend Stock Advisor

 Dividend Stock Advisor

Assessing Three Energy Names

BY David Peltier | 10/23/14 - 02:32 PM EDT
Stocks in Focus: NGLS, KMI, VNR

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 covered.

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 Permian basin.

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 midstream MLPs.

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 past.

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 quarters.

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 roof.

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 a dividend.

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 around $38.92

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

Trolling for New Ideas During Earnings
Stocks in Focus: T, GE, KLAC, PFE, TMP, SO, APD, COP, MO, SON

In this issue we offer four earnings reviews, six earnings previews, one company update and two dividend reminders.

10/23/14 - 12:02 PM EDT
Looking at Five More Energy MLPs
Stocks in Focus: MWE, MMP, EPD, ETP, EEP

Today, we are focusing on large master limited partnerships that are most leveraged to potentially lower energy prices.

10/20/14 - 03:13 PM EDT

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