Why I Couldn't Resist Buying This Ultra High-Yield Stock

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I recently culled several investments from my portfolio either to harvest a tax loss or because the options were about to expire. That left me with some cash that I wanted to put back to work in generating income. While it is getting harder to find good income stocks in this red-hot stock market, I did unearth a few that I believe can deliver market-beating total returns in the coming years.

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One of those recent additions was Crestwood Equity Partners (NYSE: CEQP), which is a midstream master limited partnership (MLP) that yields an irresistible 9.5%. While that yield initially caught my eye, what sold me on the investment was the company's rapidly improving financial situation and dirt-cheap price, which I believe will enable it to increase that already lucrative payout and fuel double-digit total annual returns for my portfolio.

The metrics that matter are all now much better

It's rare to find a yield close to double-digits that's on solid ground, but that's just where Crestwood's payout is these days. Through the third quarter of last year, the company was on track to generate between $210 million to $230 million in distributable cash flow (DCF) for 2017, providing it with enough money to cover its distribution to investors by 1.2 to 1.4 times, which is a very conservative level for an MLP. Meanwhile, the company ended the quarter with a leverage ratio of 4.1 times, which was at the low end of its 4.0 to 4.5 times target range and a solid level for an MLP.

These metrics have vastly improved from just a few years ago. In 2015, for example, the company paid out everything that came in thanks to the impact of declining oil prices, resulting in distribution coverage falling to a tight 1.0 times for the full year and an even more concerning 0.8 times in the fourth quarter. Leverage, meanwhile, was an elevated 4.8 times that year.

The company addressed those leverage concerns by selling a 50% stake in its Northeast natural gas storage and pipeline business to Consolidated Edison (NYSE: ED) in 2016. Meanwhile, it fixed its coverage issue by dramatically reducing its distribution, which also freed up cash flow to help pay off more debt. Those moves and others that followed have paid off because they've enabled Crestwood to shore up its balance sheet even as it has financed high-return growth projects.

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Stepping on the gas

Those expansions started paying dividends last year, with the company's Arrow System expansions in the Bakken Shale helping provide some incremental earnings in the third quarter. In addition to that, the company started up its Nautilus System in the Delaware Basin last year, while also selling a stake in that network to Shell Midstream Partners (NYSE: SHLX) to help finance future expansion. Meanwhile, the company ended the year by commissioning its Bear Den natural gas processing plant in the Bakken.

Crestwood Equity has more expansion projects under way for 2018, including additional expansions along its Arrow System and a gas processing plant and pipeline system in the Delaware Basin. These projects, along with those finished in 2017 and a 5% step-up in cash distributions from its joint venture with Consolidated Edison, should supply the company with around $35 million in incremental earnings in 2018. That rising cash flow could enable the company to start growing its payout again by the second half of the year.

Meanwhile, additional projects coming down the pipeline, including the recently sanctioned second phase of Bear Den and future expansions of Nautilus due to the growth of Shell Midstream's parent company, put Crestwood on pace to produce more than $120 million of incremental earnings by 2021. That visible cash flow growth leads analysts at UBS to estimate that Crestwood could support 5% annual distribution growth over that timeframe.

Great numbers for an irresistible price

Crestwood's well-supported high-yielding distribution, improving balance sheet, and visible growth prospects alone are enough to make it a top MLP to buy. However, what pushed it over the top for me was its irresistible valuation, which at just eight times DCF, is unjustifiably low since most MLPs trade for around 15 times DCF. While it could be a while before the market rewards Crestwood with a valuation closer to the peer group average, it has significant upside as that happens. Add that upside to its lucrative and likely growing distribution, and it increases the odds that my investment in Crestwood can deliver total returns that outpace the market in the coming years.

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Matthew DiLallo owns shares of Crestwood Equity Partners LP. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.