Oil and gas master limited partnerships (MLPs) have risen from the dead, but don't get seduced by MLPs with high dividend yields that are unsustainable. These "energy zombies" are eating the brains of investors who should know better.
One such stock to shun is midstream MLP Sunoco Logistics Partners (SXL) , which sports an ostensibly attractive dividend yield of 8.32%. Consider yourself warned: SXL's high dividend yield is a dangerous trap, which would snap shut if volatile oil prices took another tumble. Sure, oil prices are rising today, but they could easily resume their downward path if a recession hits in 2017, as many analysts now warn.
Sunoco Logistics in November announced a nearly $20 billion merger with MLP Energy Transfer Partners, which is embroiled in the bitterly contested Dakota Access Pipeline project.
Expected to close in the first quarter of 2017, the marriage would create the second largest MLP as measured by enterprise value, by bringing together a leading crude oil midstream MLP (Sunoco Logistics) with a leading natural gas midstream MLP (Energy Transfer Partners).
The merger is among a recent flurry of multi-billion dollar deals in the midstream energy storage and pipeline sector, as the MLP sector consolidates to foster economies of scale and shore up balance sheets.
More MLP mergers are likely to be announced during the early days of 2017, as the Trump administration pushes deregulation and lifts restrictions on oil and gas operations. Under Trump, energy pipelines stand to be big winners. But not all of them.
Based in Pennsylvania, Sunoco Logistics transports and stores crude oil, refined products and natural gas liquids (NGLs) throughout the southwest, midwest and northeastern U.S.
With a market cap of $7.9 billion, SXL operates about 5,900 miles of crude oil trunk and gathering pipelines, with interests in three crude oil pipelines. It also operates about 1,800 miles of refined products pipelines and 40 active refined products marketing terminals.
Rising oil prices are now propelling the MLP sector, which had been struggling during the energy patch downturn. Over the past 12 months, Sunoco Logistics has gained 26.8%, compared to a gain of 31% for the benchmark Alerian MLP ETF and 20% for the S&P 500.
At first blush, Sunoco Logistics' juicy dividend yield makes the stock seem like a perfect candidate for income-hungry investors. But the picture is less appealing if you look closer.
The payout ratio of an MLP indicates the sustainability of its dividend yield, by comparing the distribution to the income that pays for it. Sunoco Logistics' dividend payout ratio is 221.7%, which is far too high. To ensure a sustainable MLP dividend yield, investors should seek payout ratios below 90%.
According to the strategists at CapitalCube, Sunoco Logistics sports a "low quality" dividend. The highly capital-intensive midstream industry still struggles with onerous debt from its reckless expansion during the energy sector's go-go days when oil prices hit a high of about $110 in mid-summer 2014.
The more an MLP relies on fee-based income, the more secure its distribution. A lower payout ratio also indicates that the company has more room to increase its dividends. Sunoco's high payout ratio and over-reliance on debt (which now stands at $6.01 billion) suggests that its projects aren't sufficiently profitable, making the stock a risky proposition. The MLPs acquisition of ETP will only add to SXL's leverage.
With a trailing 12-month price-to-earnings ratio (P/E) of 48.31, SXL also is more expensive than its peers, which on average trade at a trailing P/E of about 43.
There are safer growth bets in the resurgent energy sector right now than Sunoco Logistics Partners. Buyer beware.
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John Persinos is an analyst and editor with Investing Daily. At the time of publication, he owned none of the stocks mentioned.