Two facts about Buckeye Partners, L.P. (NYSE: BPL) should interest investors in search of income today: The partnership's units yield an impressive 11%, and that distribution has risen annually for 22 consecutive years. However, the high yield is the result of a unit price that is down 20% so far this year and off around 45% from the highs reached in 2014. There's clearly something going on, but there are four signs that portend a turnaround.
Why so down?
There are a number of reasons for Buckeye's low unit price. The first is that investors have soured on the midstream energy partnership space, pushing the Alerian MLP ETF down 11% in 2018 and, like Buckeye, 45% lower since the index's highs reached in 2014. Even industry bellwethers like Enterprise Products Partners L.P. (NYSE: EPD) are getting hit hard, with this diversified giant off over 35% since mid-2014.
Image source: Getty Images.
There's little Buckeye can do about investor sentiment turning against the entire midstream sector. But the partnership, which is focused around a portfolio of global storage assets and domestic pipelines, has been getting hit extra hard lately -- and perhaps for good reason. Its distribution coverage dipped to 0.97 in the third quarter of 2017 and was a tight 1 for the year.
Possibly even more troubling for income investors is the fact that Buckeye stopped increasing its distribution on a quarterly basis. That shift, which perhaps not so coincidentally started in the third quarter of 2017, was made to preserve cash for its growth plans. The decision came shortly after the partnership spent more than $1 billion to acquire a 50% stake in VTTI, a globally diversified midstream storage provider. It certainly looks like that deal has stretched Buckeye's finances.
And despite Buckeye's coverage already being tight, it is continuing to push forward with plans to spend more money, including on a 600-mile pipeline in Texas. But that's just one project. It also has plans for additional pipelines and upgrades at its storage assets over the next couple of years. So Buckeye expects to spend as much as $325 million in 2018, with more likely to come, right when the company's distribution coverage is tight after a major acquisition. No wonder investors have been extra negative on Buckeye's units.
A trip down memory lane
Some context is important here. The first reason to be positive is that Buckeye has been down this road before. It allowed distribution coverage to fall below 1 in 2013 and 2014 while it invested for the future. Its coverage ratio was 1 or better in each of the next three years as the investments it made bore fruit. So relatively weak distribution coverage shouldn't come as a surprise as Buckeye embarks on another round of intense capital spending, underpinned by the VTTI acquisition.
Buckeye's coverage has been weak before during investment cycles. Image source: Buckeye Partners, L.P.
A second reason for optimism is the fact that the partnership's decision to stop quarterly increases isn't out of line with the broader industry. Enterprise announced plans to lower its distribution growth rate so it could self-fund more of its investments. Buckeye is, effectively, doing a similar thing. That said, the coverage shortfall in the third quarter was partly because of units issued to fund the VTTI deal, which didn't start contributing to cash flow in a meaningful way until the fourth quarter -- when coverage improved to 1.01 times.
A third positive is that Buckeye has gotten creative, issuing a new class of units to institutional investors. The units have a payment in kind feature, that allows Buckeye to issue units instead of cash to cover distributions on the units. Management believes this decision will remove the need to issue equity in 2018 and 2019. As such, it has already funded a notable portion of its current growth plans. So, despite the partnership's high yield, the company won't have to resort to issuing large amounts of debt to cover its capital budget. That gives it two years to start to see results from the VTTI deal and its other spending plans.
The fourth and last reason to have an upbeat view here is Buckeye's financial strength. It's kept its investment-grade credit rating. To give a relative view here, Buckeye's debt-to-EBITDA ratio is roughly the same as Enterprise's right now. The former isn't an overleveraged company just trying to hold on -- it shouldn't have material issues accessing the debt markets. And with the equity portion of the costs already covered, Buckeye appears to have the financial leeway to invest and support its distribution.
Things could change, but...
There's no way to predict the future, but if Buckeye's past is any guide, there's good reason to be hopeful. Although it's probably not a good option for conservative investors, the financially strong partnership's weak distribution coverage will likely be a fleeting issue as VTTI and the other investments it's making start to produce cash flow. As for the distribution streak, well, there's more than a year before another hike is needed to maintain that record, which is plenty of time for the business to start generating more compelling results. For investors willing to deal with a little near-term uncertainty, Buckeye's high yield should look enticing.
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