Summit Midstream Partners (NYSE: SMLP) is one of the highest-yielding master limited partnerships (MLP) at the moment, at 10.2%. However, instead of being a sign of trouble, that sky-high yield is an indication that the company sells for a bargain-basement valuation. That makes it stand out in this red-hot market where many stocks fetch rich prices.
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Digging into Summit's value proposition
While Summit Midstream Partners has yet to report its full-year results, it had generated enough distributable cash flow (DCF) through the third quarter to cover its 10.2%-yielding payout by a comfortable 1.16 times. In addition, it ended that quarter with a leverage ratio of just 3.22 times. Both numbers were better than the company's long-term targets to keep distribution coverage above 1.1 times and leverage between 3.5 times to 4.0 times, suggesting that the double-digit yield is on solid ground.
The main reason its yield is more than 10% is that Summit sells for a dirt-cheap valuation after losing more than a third of its value in the past three years. With the company on pace to pull in about $2.67 per unit in DCF last year, it implies that Summit sells for just 8.3 times DCF. That's well below where other MLPs trade at these days. For example, Magellan Midstream Partners (NYSE: MMP) sells for around 17 times DCF even though it has similar metrics, with its coverage ratio averaging 1.25 times while leverage is less than 3.5 times. Meanwhile, EnLink Midstream Partners (NYSE: ENLK) trades at about 12 times DCF even though it has a razor-thin 1.0 times coverage ratio and leverage of around 3.7 times.
Why is Summit so cheap?
What seems to be weighing Summit down is a deferred payment it owes its parent for an acquisition completed in 2016. At that time, Summit made an initial cash payment of $360 million and needed to pay the balance by the end of 2020. The companies didn't set that final amount in stone at the time but instead based it on a formula. Summit currently estimates that it will owe $656.5 million, which is down from a previous estimate of $793.3 million.
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While the uncertainty surrounding the exact amount it will owe is putting downward pressure on the valuation, the other factor is how the company will finance this payment. However, with more than $1 billion available to it on its credit facility and the ability to issue equity directly to its parent to pay for the deal, it has ample resources to do so without impacting its high-yielding distribution.
Another weight pushing down Summit's value is the lack of recent growth. For example, it hasn't increased its distribution since 2015 and earnings in 2017 were on track to be roughly flat with 2016. Contrast that with Magellan, which increased its distribution 8% last year and plans to boost it by another 8% in 2018. With growth fetching a premium price, Summit hasn't deserved to sell for as much as faster-growing rivals. That said, the company has plenty of growth coming down the pipeline.
For one, Summit signed an agreement with ExxonMobil (NYSE: XOM) last July to develop natural gas gathering and processing infrastructure in the Delaware Basin to support its growth. The company is investing $110 million into the initial build, which should be in-service by the second quarter. It expects to expand this platform in the coming years as Exxon increases production as well as by potentially adding third-party users to the system. In fact, it sees a more than $5 billion midstream infrastructure opportunity in this region alone, and is currently evaluating more than $500 million of expansions. For a $3 billion company, these projects have the potential to move the needle. Also, anticipated production growth across several other shale plays should help fill up the capacity of its existing assets, driving cash flow growth.
Get paid incredibly well to wait
Summit Midstream Partners is an incredible bargain right now. That's because the market has focused on a large upcoming deferred payment and its lack of growth in recent years instead of the fact that it has ample resources to make that payment and it has plenty of growth coming down the pipeline. As a result, investors not only get Summit for a great price but get paid more than 10% while they wait for the market to realize it's practically giving this pipeline company away.
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