These 2 "Low-Risk" Dividend Stocks Got Rocked This Week
"Risk is what's left when you think you've thought of everything."
-- Carl Richards, The Behavioral Gap
This past week has been a rough one for pipeline MLPs. Investors pummeled the sector on Thursday after learning that the Federal Energy Regulatory Commission (FERC) would no longer allow oil and gas MLPs to add an income tax recovery charge to the fees they collect on their pipelines. Among the hardest hit were Enbridge Energy Partners (NYSE: EEP) and TC Pipeline (NYSE: TCP), which plunged 17.5% and 19%, respectively, this week. It was a serious tumble for two companies that bill themselves as low-risk options for income investors.
From solid to suspect with the stroke of a pen
Enbridge Energy Partners is coming off a challenging year as issues in its now former natural gas gathering business caused cash flow to fall, taking its valuation with it. That prompted the company -- and its Canadian parent, Enbridge (NYSE: ENB) -- to take action to shore up the MLP's financial situation. The two companies completed a series of strategic initiatives, including a sale of the troubled the gas gathering business to Enbridge, to get MLP back on solid ground. Those actions transformed Enbridge Energy Partners into a "pure-play, liquids pipeline MLP with a low-risk commercial profile, stable cash flows, a strong balance sheet, healthy distribution coverage, visible growth and limited external capital needs," according to the companies. One evidence of that was the fact that the company anticipated that it would generate $775 million to $825 million in cash flow this year, enough to cover its reset distribution rate by a comfortable 1.2 times.
That cushion came in handy when the U.S. government enacted a massive tax cut at the end of last year, which would impact the income tax allowance component of the tolls the company charged on one of its FERC-regulated pipelines. With the U.S. corporate tax rate dropping from 35% to 21%, Enbridge Energy Partners had to reduce its fees on that system. As a result, the company reduced its cash flow guidance to a range of $720 million to $770 million this year, which was still enough to cover its payout by a comfortable 1.15 times. That led company President Mark Maki to affirm that "EEP is now well positioned with one of the lowest business risk profiles in the sector," thanks to the transition completed last year.
However, with the recent FERC announcement, Enbridge Energy Partners can no longer collect any allowance for income taxes on this system. That one change will impact cash flow by $60 million this year, pushing it down to a range of $650 million to $700 million, which is just enough to cover the company's distribution. That's a little too tight and suggests the company might need to cut its now 13%-yielding payout once again.
TC Pipelines, meanwhile, has investments in eight FERC-regulated "low-risk energy infrastructure pipelines." The natural gas pipeline MLP, which also has a Canadian parent in TransCanada (NYSE: TRP), has yet to release what, if any, impact the change will have on its cash flow going forward. However, the company did state earlier this year:
That said, with even the reduced income tax allowance going away, this impact will likely be even greater. That puts the company's now 10%-yielding payout at risk of being cut since TC Pipielines only covered it by 1.1 times last year.
Blindsided by the risk no one saw coming
Both Enbridge Energy Partners and TC Pipelines thought that operating FERC-regulated pipelines lowered their risk profile. However, in a surprising move, the entity they relied on for income protection disallowed an important allowance. This change will cut into the cash flow these companies collect on some of their key systems, increasing the risk that both might need to reduce their lucrative payouts.
That said, it is worth noting that the FERC ruling only relates to MLPs. As a result, they have some potential options to offset this change by working with their corporate parents, Enbridge and TransCanada. It's one of the many things investors should keep an eye on this year as this high-yield duo works through this surprising change that upended their seemingly low-risk business profiles.
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Matthew DiLallo owns shares of Enbridge and Enbridge Energy Partners. The Motley Fool owns shares of and recommends Enbridge. The Motley Fool has a disclosure policy.