Published by Nick McCullum on October 12, 2017
The 8 Rules of Dividend Investing recommends selling a security whenever a dividend cut occurs.
A dividend cut indicates one of two worrisome characteristics:
- A company is unable to continue paying its current dividend
- A company is unwilling to continue paying its current dividend
In either case, investors have reason to avoid stocks that cut their dividends.
Earlier today, Genesis Energy (GEL) announced that it had cut its dividend to $0.50 from $0.7225 previously. Accordingly, the company no longer garners a ‘buy’ recommendation from Sure Dividend.
This article will discuss Genesis Energy’s recent distribution cut with an emphasis on why the distribution cut was unpredictable, why the partnership decided to reduce its distribution payment, and when investors should sell this security.
Genesis Energy is a master limited partnership with a market capitalization of $3.2 billion. Founded in 1996, the partnership is headquartered in Houston, Texas and operates in four (now five) reporting segments:
- Offshore Pipeline Transporation
- Onshore Facilities and Transporation
- Refinery Services
- Alkali Soda Ash (a new operating unit after a recent acquisition that closed in early September)
- Marine Transporation
Genesis Energy’s operations are geographically diversified across the United States and primarily located in Texas, Louisiana, Arkansas, Mississippi, Alabama, Florida, Wyoming and the Gulf of Mexico.
Recent Financial Performance & Dividend Cut
Until recently, Genesis Energy’s performance had been excellent. The company was known for raising its distribution in most quarters and usually reporting distributable cash flow that exceeded its quarterly distribution payments.
Genesis’ performance took a turn for the worse with the company’s second-quarter earnings release, which was announced on August 3rd.
The partnership reported revenues down 8.8%, net income up 42%, and adjusted EBITDA down 5.2% from the same period a year ago. The partnership’s year-over-year revenue decline was largely attributed to ‘extraordinary’ planned and unplanned downtime at some of the partnership’s refinery customers in the Gulf of Mexico.
In the same announcement, Genesis reported that the partnership entered into a $1.325 billion agreement with Tronox Limited in which Genesis will buy Tronox’s alkali business – the world’s largest producer of sodium carbonate, responsible for ~28% of global production.
Genesis funded the purchase by tapping the capital markets. The partnership issued $750 million of convertible preferred units and $550 million of 6.50% senior unsecured notes due 2025 which were priced at face value. Subsequently, Genesis Energy announced two price increases for products in the newly-acquired alkali business:
- Genesis Alkali to Raise Off-List Prices for USP and Industrial Grade Sodium Bicarbonate
- Genesis Alkali to Raise Off-List Prices for Animal Nutrition Products: S-Carb® and Feed Grade Sodium Bicarbonate
More recently, the company’s distribution cut was announced just this morning. We were surprised that the partnership had decided to cut its distribution, as Genesis reported a distribution coverage ratio of 1.02x at the end of the most recent quarter. In addition, Genesis Energy reports that its legacy business continues to perform in-line with expectation and its newly-acquired alkali business is exceeding expectations.
Genesis Energy still believes that a distribution cut is the best choice for its unitholders. The company is committing to distribution growth of at least $0.01 per quarter moving forward. Additional details can be found below.
Source: Genesis Energy October 2017 Investor Presentation, slide 3
The main imperative that drove Genesis Energy’s distribution cut is to accelerate the deleveraging of its business. Low oil prices and the additional debt issued to fund the Tronox alkali acquisition have left Genesis Energy’s leverage ratio much higher than it would like.
More specifically, in Genesis Energy’s second quarter earnings release, the partnership reported an adjusted debt to EBITDA ratio of 5.4x. The partnership is targetting a long-term debt-to-EBITDA ratio of 3.75x, which indicates that it must deleverage itself over the next several years. Post-dividend-cut, the partnership now has a well-defined deleveraging ladder, which can be seen in the following slide.
Source: Genesis Energy October 2017 Investor Presentation, slide 4
Investors who buy now will have much greater distribution safety moving forward. The partnership is targeting a distribution coverage ratio of 1.40x to 1.60x over the subsequent twenty quarters, which is up significantly from last quarter’s distribution coverage ratio of 1.02x.
Here’s what Genesis Energy’s Chief Executive Officer had to say about the partnership’s distribution cut.
“As noted above, our legacy operations continue to perform in line with expectations and, importantly, our recently acquired soda ash business is performing better than expected. As contributions from recently completed organic growth projects and acquisitions ramp, we expect to generate record net income, cash flows from operations, Adjusted EBITDA and Available Cash before Reserves in future quarters and fiscal years. If and when we experience any cyclical recoveries in some of our businesses which have faced headwinds over the last several years, such financial performance would be additive to our expected record results. Absent material, unexpected changes to the underlying fundamentals of our aggregate businesses, or other potential higher valued uses of capital, we would target to continue the minimum quarterly growth referenced above for at least each of the next twenty quarters.
To achieve our objective to deliver the best value to unitholders over the long term, we strive to continue to generate and grow stable, repeatable cash flows while never losing sight of our absolute commitment to safe and responsible operations. We believe we have very attractive businesses with significant barriers to entry, long commercial lives, and which have performed relatively well over many, many cycles, not just the down‐cycle of the last three years. The steps we are announcing today will give us the flexibility to build on the successes of our footprint as it stands today.” – Grant Sims, CEO of Genesis Energy
Make no mistake – we are unhappy about the distribution cut. With that said, it does appear that Genesis Energy’s management has the best interests of its investors in mind. The partnership’s ~31% distribution cut was aimed at reducing leverage, which should help the partnership’s performance in future recession. The obvious downside is that continuing investors will now have a much lower yield on cost than before the ~31% distribution cut.
As mentioned, a dividend cut triggers an automatic sell using The 8 Rules of Dividend Investing. It does not trigger an immediate sale. Investors who sell Genesis Energy right now are likely to ‘lock in’ significant losses given the stock price’s dramatic decline in 2017.
If oil prices rebound further (as we expect), then Genesis Energy’s price is likely to rise too. Moreover, the company’s stock is likely to rebound slightly as the markets digest the news of its dividend cut.
Now is not the time to sell Genesis Energy. We recommend holding this stock and continuing to collect its dividend (which still yields an impressive ~7.7% as I write this) until its price rises to more reasonable levels.
Genesis Energy’s distribution cut is highly disappointing.
The partnership reported a distribution coverage ratio of 1.02x in the most recent quarter We and more recently stated that its legacy business is performing in-line with expectations and its newly-acquired alkali business is outperforming expectation.
The partnership still cut its distribution. We recommend holding these units until they rise to a more appropriate price, and then selling them in exchange for more high-quality energy securities.