Western Gas Partners (NYSE: WES) has tumbled over the past year, losing more than a quarter of its value at a time when the market has mostly been on the upswing. Because of that decline, and a 7% increase in its distribution over the past year, the master limited partnership (MLP) now yields an attractive 8.6%. It's a payout that not only looks sustainable, but appears poised to continue increasing over the next two years.
A solid foundation
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Last year was another solid one for Western Gas Partners. The company generated $929 million in distributable cash flow (DCF), up 9% from 2016, which was enough to cover its rising high-yield payout by 1.13 times. Several factors fueled that growth, including higher volumes on its legacy systems and the completion of some expansion projects. In addition to that, the company completed a strategic asset trade with Williams Partners (NYSE: WPZ), swapping its minority stakes in two natural gas gathering systems in the Marcellus Shale, along with $155 million in cash, for full control of a gathering system in the red-hot Delaware Basin. That deal provided Williams with two assets that were a better strategic fit, along with some much-needed cash, while streamlining Western Gas' portfolio.
The company also shored up its financial situation in the past year, taking advantage of its strong credit rating to borrow $1.1 billion of low-cost debt. That gave the company the money it needed to continue funding expansion projects without having to issue equity at the current low price.
A look at what's coming down the pipeline
Western Gas Partners expects to put that cash to work this year, with it planning to invest $1 billion to $1.1 billion on a variety of expansion projects in both the Delaware and DJ Basins. That's a 32% increase in spending from last year and should help fuel a more than 13% improvement in earnings in 2018. Further, as those projects come online, they'll help boost the company's distribution coverage ratio from the very tight 1.0 times it anticipates in the first half of the year to a much more comfortable 1.2 times in the second half of 2018. Further, those expansions put the company in the position to increase its high-yield payout by another 7% this year and 6% in 2019.
In addition to this internal growth, the company should also benefit from its relationship with U.S. oil giant Anadarko Petroleum (NYSE: APC), which formed the MLP several years ago to acquire, develop, and operate midstream assets. Since that time, Anadarko has dropped down several of its internally developed midstream assets to the MLP. That's worth noting since the U.S. oil giant expects to invest another $550 million in building out additional midstream infrastructure in the DJ and Delaware basins this year, giving it more assets to potentially drop down to the MLP in the future. It's a sizable opportunity overall considering that Anadarko's midstream assets should generate more than $300 million of annual earnings by the end of 2018. Meanwhile, Western Gas Partners could also possibly acquire additional assets from third parties like it did in last year's deal with Williams Partners.
These growth fuels seem to suggest that Western Gas Partners should have no trouble increasing its distribution in the coming years, especially with its coverage ratio on the rise. However, there is one potential headwind worth noting. Western Gas Partners is one of a shrinking number of MLPs that still pay out incentive distribution rights (IDRs) to a parent company, Western Gas Equity (NYSE: WGP), which Anadarko formed to collect those lucrative management fees. Several of its peers have undertaken transactions in recent years to eliminate those burdensome fees. This is a concern because some of these MLPs -- Williams included -- had to issue so much equity to eliminate the IDRs that they also needed to reduce their lucrative distributions to even things out. While Western Gas has said it has no plans to address its IDRs, the company could change course if those fees continue weighing on its valuation. Though, even if it completes a simplification transaction with Western Gas Equity, that doesn't necessarily mean it will reduce the payout.
Many reasons to be optimistic
Western Gas Partners currently believes it can continue growing its high-yield payout for at least the next two years. Backing that view is the more than $1 billion of expansion projects the company has under way, which should boost cash flow enough in the coming years to increase the payout as well as the coverage ratio. On top of that visible growth, the company has additional upside from its relationship with Anadarko. While the costly management fees Western Gas pays its parent could derail that plan, the company doesn't see them being an issue. Because of that, it seems highly likely that Western Gas will continue rewarding investors with a rising income stream in the coming years.
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