Midstream/MLP 2Q20 Dividends/Distributions Hold Steady

Summary //

Based on our broadest midstream index, the Alerian Midstream Energy Index (AMNA), 37 of 42 dividend-paying constituents maintained their payouts sequentially, four grew, and MMLP was the only cut.
We continue to view the larger names in the space as well positioned overall to maintain their payouts and see less risk from smaller names given sizable cuts already instituted or significant cash flow stability (or even growth) for some names.
Equity yields remain stubbornly high even as the risk of additional distribution cuts seems limited, though some unique situations continue to bear watching.

For midstream, 1Q20 dividends (those paid in 2Q20) were being announced at the height of macro energy headwinds in April when the demand impact from COVID-19 was most severe. Many energy infrastructure companies chose to reduce their payouts to prioritize financial flexibility and conserve cash in an unprecedented and uncertain environment. Altogether, twenty midstream names cut their 1Q20 dividends or distributions, though these tended to be smaller names by market capitalization. The larger companies mostly stood pat given a more diversified asset base, stronger financial positioning, and other factors that left them better positioned to weather market headwinds. (See our 1Q20 dividend recap for more detail.) With an improved macro backdrop and proactive cuts completed in 1Q, the downside risk in distributions is diminishing. Today’s piece recaps 2Q20 payouts for midstream and discusses the outlook for distributions from here.

2Q20 Distributions/Dividends: A few growers and one cut as most stay steady.
While uncertainty remains and a recovery in energy demand is ongoing, the backdrop for second quarter dividend announcements in July and early August was much more constructive than for the first quarter. Our expectations for second quarter midstream dividends were few, if any, cuts but also few examples of sequential growth. Actual second quarter dividend announcements were fairly in line with expectations with only one cut across the universe by a small MLP – Martin Midstream Partners (MMLP). The charts below show the quarter-over-quarter (Q/Q) changes to distributions/dividends for the constituents of the Alerian MLP Index (AMZ), Alerian MLP Infrastructure Index (AMZI), and Alerian Midstream Energy Select Index (AMEI) by comparing 2Q20 with 1Q20. To be clear, 2Q20 payouts refer to the dividends that will be paid in 3Q20. For the constituents of the AMEI that pay monthly dividends – Inter Pipeline (IPL CN), Keyera (KEY CN), and Pembina Pipeline (PPL CN) – the dividend for July 2020 was compared with the declaration for April. AMEI constituents Cheniere Energy (LNG), Tellurian (TELL), and Macquarie Infrastructure (MIC) do not pay a dividend. To summarize using our broadest midstream index, the Alerian Midstream Energy Index (AMNA), 37 of 42 dividend-paying constituents maintained their payouts sequentially, four grew, and MMLP was the only cut.

A handful of MLPs grew their distributions sequentially for 2Q20, while C-Corps all maintained. Hess Midstream (HESM), Delek Logistics (DKL), and Cheniere Energy Partners (CQP) increased their distributions approximately 1% sequentially. All three had increased their payouts for 1Q20 as well. Alongside the announcement that it is being acquired by CNX Resources (CNX), CNX Midstream (CNXM) announced a 2Q20 distribution of $0.50 per unit – up from $0.0829 per unit in 1Q20. Per the merger documents, CNXM is barred from making any additional distributions without the consent of CNX.

Year-over-year comparison likely less relevant.
Given market headwinds and a fragile recovery, most midstream names are maintaining payouts instead of increasing them. As noted already, HESM, DKL, and CQP are notable exceptions. It also bears noting that Enbridge (ENB) and TC Energy (TRP) typically raise their dividends on an annual basis with the fourth quarter dividend. TRP has guided to dividend growth of 8-10% in 2021 and 5-7% beyond 2021. Given the dramatic change in operating environment from 2Q19 to 2Q20, the year-over-year comparison below is less relevant than in the past; however, it is included for context. The charts below compare the 2Q20 payout with 2Q19 for names in the indexes in both periods. This admittedly introduces survivorship bias. AMZ and AMEI constituent Rattler Midstream (RTLR) was excluded below since its first distribution was for 3Q19. As shown, several constituents have seen in an increase in their payouts on a year-over-year basis, but that is more a reflection of increases in 3Q19 or 4Q19.

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Are distribution/dividend cuts firmly in the rearview?
A steady quarter for payouts and an improving macro backdrop (read more) are positives for midstream and are helpful for restoring confidence in the space. Given cuts made earlier this year and firmer footing in terms of fundamentals, the downside risk for midstream payouts overall feels substantially lower yet yields remain stubbornly elevated. As of August 7, the AMZI, AMZ, and AMEI were each yielding 370, 360, and 180 basis points above their respective five-year averages. We continue to view the larger names in the space as well positioned overall to maintain their payouts and see less risk from smaller names given sizable cuts already instituted or significant cash flow stability (or even growth) for some names.

While the downside risk to distributions has diminished in our view, it would be premature to say that the risk of distribution cuts is completely behind the space. On their earnings call on July 31, Phillips 66 Partners (PSXP) indicated that a shutdown of the Dakota Access Pipeline (DAPL) would be cause to evaluate the partnership’s distribution. On August 5, an appeals court ruled that the pipeline could continue operating; however, the court is still evaluating arguments from the Army Corps and DAPL that an environmental review is not needed, which leaves some lingering uncertainty. On its August 5 earnings call after the court’s decision, the management of Energy Transfer (ET) expressed confidence that the pipeline would continue to operate. When asked about the distribution and the company’s investment-grade credit rating, ET’s CFO mentioned that the distribution is a topic when discussing how to reduce leverage with rating agencies. For context, ET’s distribution coverage ratio for 2Q20 was 1.54×. To be fair, these are unique circumstances, but they help inform the cautiously optimistic outlook for distributions going forward.

Bottom Line
Dividend cuts have been prevalent across the energy sector this year, with BP’s (BP) recent announcement of a 50% dividend cut perhaps the latest addition to a long list including Royal Dutch Shell (RDS-A), Halliburton (HAL), and many others. Within this context, it is reassuring to see only one cut across the midstream universe for 2Q20 and from a small MLP at that. Equity yields remain stubbornly high even as the risk of additional distribution cuts seems limited, though some unique situations continue to bear watching. The steady payouts in 2Q are positive, and ongoing stability will likely be conducive to attracting income-seeking investors to this space.

Midstream/MLP 2Q20 Dividends/Distributions Hold Steady

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