The following is a guest blog post:
Over the past few years, the midstream space has witnessed a lot of changes. About a year after the oil price collapse in 2014, oil production in the US began to decline. As both volumes and commodity prices went down, midstream companies that had pursued growth at all costs, levered up the balance sheet in pursuit of that growth, and those companies that added significant commodity price exposure in their agreements with producers, found themselves in a very precarious financial situation. Not a small number of midstream companies eventually cut their distributions/dividends in order to shore up the balance sheet and fund growth obligations.
However, there are were also many midstream companies with management teams who were disciplined capital allocators, adept in avoiding agreements that would introduce additional volatility from direct commodity exposure, and ultimately made all the right decisions for their business and shareholders. It’s my personal view that an investor needs to learn about, and get comfortable with, a management team before investing in their company’s shares. For that reason, I started a podcast called Investing with the Buyside, which aims to provide corporate access to all investors.
Before starting the IwtB Podcast, my job was to perform equity research for a large mutual fund company based out of Denver. My sector focus was energy, utilities, and a few industrial subsectors. My decision to leave the buyside and start the IwtB Podcast was primarily because I believe all investors should have the opportunity to hear management talk about their business, industry outlook, capital allocation philosophy, as well as hear management’s perspective on the value of their stock.
Another, more minor, reason I wanted to leave the buyside was that many of the companies and some of the subsectors I covered appeared significantly undervalued – midstream being one of them. There are a lot of trading restrictions for someone working for a large money management firm and if there was ever a good time to leave the industry and try something new, it was then.
Since starting the IwtB Podcast, I’ve had some extremely informative and helpful conversations with management teams of companies that pay really juicy dividends. For example, my first management team interview was with Pat Sanchez, COO of Sanchez Midstream Partners (SNMP). At the time of writing this, SNMP has a ~15% distribution yield and is expected to have coverage greater than 1.2x this year (coverage is the inverse of a payout ratio). Another interesting dividend story is Summit Midstream Partners (SMLP), which has a ~14% distribution yield. The IwtB Podcast had SMLP’s Founder and CEO, Steve Newby, on the program a few weeks back and he was quite emphatic on his commitment to and the stability of the dividend.
This brings us back to the question posed in the title of this blog. Is the midstream sector a source of stable dividends? Or, will there be more distribution cuts in the future? It’s hard to say whether a management team will ultimately cut their dividend/distribution. There are innumerable factors to consider when making an investment in any company, let alone a company that has at least some exposure to commodity prices. But what I can say is that investors are flying blind if they don’t have the opportunity to hear management talk about all of considerations that go into making capital allocation decisions.
Disclosure: the author is long SNMP and SMLP at the time of writing.