Shares of Targa Resources (NYSE: TRGP) have been under a lot of pressure over the past year due to continued volatility in the oil market. Overall, the midstream stock is down more than 35%, which has pushed its dividend yield up to nearly 10.5%.
That lower share price and higher yield likely have investors wondering if now is a good time to buy. Here's a look at the case for and against Targa Resources.
Image source: Getty Images.
The case against Targa Resources
One of the reasons the stock has tumbled in the past year is the company's weakening financial profile. That was on full display during the second quarter. It generated only $192 million in distributable cash flow, which wasn't enough to cover the $234.4 million it paid out to investors. After distributing 100% of its cash flow last year, Targa has now paid out significantly more than it hauled in through the first half of this year, which isn't sustainable.
One of the reasons Targa's coverage ratio has worsened this year is an asset sale. That gave it the funds to pay down debt so that it could fund expansion projects. But even with that sale, its leverage ratio remained elevated at 4.4 times debt to EBITDA, which is above the sub-4.0 comfort level of most midstream companies. That's why the company still has a sub-investment-grade credit rating, which makes it more challenging and expensive to borrow money.
The case for Targa Resources
While its financial metrics are a concern at the moment, they should improve significantly in the second half of the year. That's because the company has already completed $3 billion of expansions projects since the end of the first quarter and expects to finish several more in the coming quarters.
The biggest project is the Grand Prix pipeline, which will transport natural gas liquids (NGLs) from the Permian Basin to a processing hub in Mont Belvieu, Texas. It recently completed that pipeline following a two-month delay, so it will provide only a partial boost in the third quarter before the company experiences the full benefit during the fourth quarter. Targa also recently finished three natural gas processing plants, an NGL processing facility, and a smaller NGL pipeline, which should boost its second-half results.
There are several more expansion projects ready to come on line over the next year. Leading the way is the Gulf Coast Express pipeline, which fellow midstream giant Kinder Morgan (NYSE: KMI) is developing. Kinder Morgan currently expects this project to be in service late in the third quarter. Meanwhile, Targa has another natural gas processing plant coming on line in the fourth quarter and two more scheduled for 2020. It also has two more NGL facilities on track to start up over the next year.
These expansion projects have its EBITDA on pace to grow from a projected $1.35 billion this year up to around $2 billion in 2020, with additional growth in 2021. Meanwhile, it's expected that expansion spending will decline from $2.3 billion this year to $1.8 billion over the 2020 to 2021 time frame, which will enable it to generate more free cash flow. Because of this growth, Targa's financial metrics should significantly improve over the next year, which will enhance the sustainability of its high-yielding dividend.
Verdict: It's now time to consider buying Targa Resources
Targa Resources has finally reached the inflection point where its expansion projects will begin fueling accelerated earnings growth. Because of that, its financial profile will improve, which should lift the weight that has pushed the energy company's stock down over the past year. That makes now an ideal time to start buying its shares, which look poised to begin bouncing back in the coming quarters.
More From The Motley Fool
- 10 Best Stocks to Buy Today
- The $16,728 Social Security Bonus You Cannot Afford to Miss
- 20 of the Top Stocks to Buy (Including the Two Every Investor Should Own)
- What Is an ETF?
- 5 Recession-Proof Stocks
- How to Beat the Market
This article was originally published on Fool.com