Published January 6th, 2017 by Bob Ciura
The crash in oil and natural gas prices over the past two years was one of the worst periods for the energy sector in recent memory.
Business conditions got so bad that many MLPs had to cut or eliminate their distributions. This was a severe blow to investors, who buy and hold MLPs mainly for income.
But there are still many well-run MLPs that generate enough cash flow to sustain their distributions. Some have continued to raise their distributions on a regular basis, even though oil prices remain about 50% below their 2014 peak levels.
For example, TC PipeLines (TCP) has raised its distribution for 17 consecutive years. Its most recently declared distribution was 6% higher than the same distribution last year.
TC PipeLines is a Dividend Achiever. You can see the entire list of all 272 Dividend Achievers here.
It has paid 70 consecutive quarterly distributions without interruption. Today, the stock offers a hefty 6.4% distribution yield.
This article will analyze TC PipeLines’ business model and future prospects.
TC PipeLines operates in the midstream energy industry. This means it is engaged in transportation, rather than exploration and production or refining.
One major reason why TC PipeLines has been spared from of the fallout of the oil crash is because it operates in natural gas.
The company has interests in approximately 5,900 miles of federally regulated, interstate natural gas pipelines. Its assets have a total capacity for 9.1 billion cubic feet per day of natural gas.
Source: Wells Fargo Annual Energy Symposium, page 4
The Partnership is managed by its general partner, TC PipeLines GP, Inc., a subsidiary of TransCanada Corporation (TRP).
Another reason why the company’s distribution growth remained unimpeded through the commodity crash is because its assets are predominantly fee-based.
These assets are extremely stable, because they are managed under take-or-pay style contracts. TC PipeLines operates similarly to a toll road, in that it collects fees based on the volumes of natural gas it transports through its assets.
As previously mentioned, TC PipeLines’ assets are regulated, which means their fees are regulated as well. Its pipelines operate under long-term FERC-approved rates.
For example, its Northern Border and Great Lakes assets received regulatory approval for rates in 2013, and neither are required to file for new rates until 2018.
And, the company has highly-diversified sources of cash flow.
Source: Wells Fargo Annual Energy Symposium, page 5
Approximately 92% of the company’s cash flow comes from long-term contracts.
This effectively shielded TC PipeLines’ cash flow from the crash in commodity prices. Over the first nine months of 2016, the company’s distributable cash flow rose 10% on a per-unit basis.
The great thing about well-run midstream companies like TC PipeLines is that there are still growth opportunities, even in a very challenging climate for the energy sector from a pricing perspective.
For example, while abundant domestic supply has lowered the price of natural gas, this should result in significant growth in demand for natural gas.
The low price of natural gas has incentivized industrial customers like utilities to switch from coal to natural gas for generating heat and electricity.
To meet the higher level of demand, TransCanada is in the midst of a huge capital spending program, which includes $13 billion of near-term growth opportunities and $45 billion of projects to be executed over the long term.
There are several projects in the near-term pipeline for TC PipeLines, that are scheduled to be placed into service over the next few years.
Source: Wells Fargo Annual Energy Symposium, page 8
This could be a significant tailwind for TC PipeLines. According to TC PipeLines management, dropdowns of the remainder of its U.S. natural gas pipeline assets from TransCanada to TC PipeLines has the potential to more than double TC PipeLines’ asset base.
TC PipeLines has a current distribution of $3.76 per unit on an annualized basis. It has more than doubled its distribution since 1999.
Source: Investor factsheet, page 1
As many investors learned, it is important to avoid companies that are not in sound financial condition. MLPs historically have relied upon external capital to finance their growth projects.
When oil and gas prices collapsed, share prices followed suit. This effectively shut off the equity market as a source of financing.
But since MLPs had already gorged themselves on debt during the production boom over the past several years, lines of credit were tapped out as well.
Suddenly, many MLPs found themselves unable to generate enough cash flow to build new projects, pay debtholders, and maintain distributions to equity holders.
This is why it is so important to analyze an MLP’s balance sheet, to make sure its debt load will not jeopardize its ability to pay distributions.
Fortunately, TC PipeLines maintained an investment-grade credit rating throughout the crash in commodity prices. It carries a BBB- credit rating from Standard & Poor’s, with a stable outlook.
It also maintains a trailing 12-month long-term debt to EBITDA ratio of 4.75. The company has a significant amount of long-term debt. But as long as it does not incur further debt, it should continue to generate enough cash flow to service its debt and maintain its distribution.
The company also has additional financial flexibility through a $500 million credit facility, $280 million of which was still available at the end of the third quarter. It also has the right to request a $500 million increase in its credit facility, which is an additional lever the company can pull if times get tight.
Its customer base is also in good financial shape. Approximately 74% of TCP PipeLines’ transportation customers hold investment-grade credit ratings.
Over the first nine months of 2016, TC PipeLines generated $3.67 of distributable cash flow per unit. It declared $2.77 of distributions per unit over the same period. That equates to a 75% payout ratio, which is comfortable enough to secure the current distribution and leave room for future increases.
Income investors should view TC PipeLines favorably. It has high-quality assets, which should benefit from the excellent fundamentals of natural gas. And, its stable cash flow and growth projects should continue to fuel distribution growth going forward.