Shares of midstream company Tallgrass Energy (NYSE: TGE) have declined about 5% this year. Because of the lower share price, the company's dividend now yields an eye-catching 9.2% when factoring in the 1.9% increase from the first quarter. That certainly makes it seem attractive to income-seeking investors.
However, with that higher yield comes an elevated risk level. That's why investors might want to consider putting Tallgrass on their watchlist for now and see if it can address a few issues before they add it to their portfolio.
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The numbers look good right now
Tallgrass Energy currently expects to generate between $760 million and $835 million in cash to pay its dividend this year. That's enough money to cover the payout -- which it intends on increasing 6% to 8% from last year's level -- by a comfortable 1.25 times for the full year. That will leave the company with some excess cash to invest in expanding its portfolio as well as to strengthen its balance sheet.
The pipeline company currently has a decent balance sheet since it ended the first quarter with a leverage ratio of 4.8 times debt-to-EBITDA. While that's a bit on the higher end, since most pipeline stocks want that number below 4.5, the company expects "our leverage ratio to decrease throughout the remainder of 2019 as we deliver another year of adjusted EBITDA growth," according to comments by CFO Gary Brauchle on the company's first-quarter conference call.
That anticipated improvement will come even though the company spent $52 million on a small acquisition during the first quarter and expects to invest between $300 million and $400 million on other expansion projects this year. The company's high-yielding dividend therefore looks sustainable.
Where does it grow from here?
The concern for Tallgrass Energy is in what lies ahead. One area to watch is upcoming contract expirations on its Pony Express oil pipeline and the west end of its Rockies Express natural gas pipeline system. The company is working on securing new agreements with shippers on both systems, which could potentially yield some incremental cash flow if it locks in the higher rates it anticipates.
The other item to watch is its longer-term growth prospects. Tallgrass Energy currently has three large-scale expansion projects in development. First, it's working with energy infrastructure giant Kinder Morgan (NYSE: KMI) on a joint venture involving the Pony Express Pipeline. This project would entail converting two of Kinder Morgan's underutilized gas pipelines in the Rockies to oil service as well as building some new pipelines that increase the flow of oil from that region to a storage hub in Oklahoma. The partnership could enable Tallgrass to increase the capacity of Pony Express from the 420,000 barrels a day it expects to reach later this summer to 700,000 BPD by the third quarter of 2020.
In addition, Tallgrass Energy has proposed building the Seahorse Pipeline that would move oil from that hub to the proposed Plaquemines export terminal on the Louisiana Coast. Tallgrass Energy is currently working on getting shippers for the Seahorse pipeline. While it has secured one anchor customer for the 800,000-barrel-a-day pipeline, it needs at least one more large shipper to push that project through. That has proved to be more challenging than initially anticipated, after rivals have proposed seven competing pipelines that would move oil from Oklahoma to the Gulf Coast. While one of those has already received enough commitments to move forward, Tallgrass believes there's enough interest in its project that it could make a final investment decision in the next few months.
If Tallgrass Energy is successful in securing new higher-rate contracts on its existing pipelines as well as moving forward with those three large-scale pipeline projects, then it could deliver high-octane earnings growth over the next few years. That could give the company the fuel to significantly increase its already high-yielding dividend, provided it can get the funding it needs to complete those expansions.
No harm in waiting
Tallgrass Energy offers investors a big-time dividend that looks sustainable since it has solid financial metrics. However, it has some longer-term growth concerns that are currently weighing it down. That's why investors might want to consider adding this high-yield stock to their watchlist to see if it can capture the opportunities it's pursuing. If it can, then this pipeline stock could potentially deliver high-octane total returns in the coming years, which would make it a much better buy for the long term.
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