NEW YORK (TheStreet) -- 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 with a two master limited partnerships 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 received a lot of questions about the Targa Resources Partners LP (NGLS) $5.8 billion acquisition of Atlas Pipeline Partners LP (APL) . The deal was announced on Oct. 13, which was during the peak of the sharp selloff 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, and will become the second-largest energy-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 increase to about 40%. Earlier this year, management said that Targa Resources was less hedged than it had been in the past.
Shares of Targa Resources have dropped about 11% year-to-date and recently traded at around $63.80. The company has a quarterly distribution of 78 cents 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 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.
Vanguard Natural Resources
Second, Vanguard Natural Resources LLC (VNR) is an exploration-and-production play. The stock has lost about 7% month to date, and the shares were recently changing hands at around $25.96.
The company is similar to at Line Energy (LINE) , which we looked at recently. 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 21 cents 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.