Sustainable income isn't just about a high yield. It's about the ability to keep paying that high yield in good times and bad. Even better is the ability to grow the distribution over time, which is why retirees looking for sustainable income should do a deep dive on Buckeye Partners, L.P. (NYSE: BPL) today. The oil and gas midstream partnership's 9% yield looks a little risky, but history suggests that the risk will pass.
Besting the bellwether
When investors look at midstream partnerships like Buckeye, the reference point is often industry giant Enterprise Product Partners L.P. (NYSE: EPD). That makes complete sense since Enterprise has an incredible streak of 20 consecutive years with annual distribution increases. Here's a fun fact, though, Buckeye's streak is 22 years.
That's not enough of a reason to just run out and buy Buckeye. However, it gives you a sense of the commitment management has to returning value to unitholders via distribution increases. In good years and bad, Buckeye has upped its disbursement. And, over the past decade, the average annualized increase was 4.8%, beating the historical average increase in inflation -- that means unitholder buying power has gone up over time, too.
The differences between Buckeye and Enterprise, however, are notable. For example, Buckeye has a market cap of around $8 billion and is focused on pipelines and a global network of storage facilities. Enterprise has a market cap of $56 billion, is widely diversified across the midstream space (including owning a fleet of ships), and is basically a domestic player. Buckeye's smaller size and focus around one aspect of the midstream business means it's inherently more risky, which is part of the reason it offers a 9% yield compared to Enterprise's 6.4%.
Distribution coverage is another big difference. Enterprise has managed to keep its distribution coverage at or above 1.2 times while supporting regular distribution hikes and investing billions in its business, even though oil prices have been weak since mid-2014. Buckeye has been more aggressive here, with its distribution coverage slipping below 1 in 2013 and 2014. In fact, the highest distribution coverage over the past five years was 1.09 times.
Another reason for the elevated yield is that Buckeye has also been more aggressive in the use of debt. Its debt-to-EBITDA ratio was higher than Enterprise's for most of the last decade. And as the chart above shows, that ratio just spiked higher again, which brings us to the real opportunity here.
Investing for the future
Buckeye's distribution coverage has again fallen below 1, hitting 0.95 times in the second quarter of 2017. That's something investors don't like to see. However, this is partly due to Buckeye's efforts to grow its business, which includes the recent purchase of a 50% interest in VTTI -- which owns a global network of storage facilities -- for $1.15 billion. That's a huge deal for Buckeye relative to its size.
Buckeye expects that investment to boost its growth prospects over the long term. But over the near term it's going to be a drag on Buckeye's finances. Not only was the upfront cost of the deal large, but Buckeye is spending another $236 million (funded 50% with debt and 50% with units) to help VTTI finance a structural change in its business. And, thus, you see Buckeye's leverage increasing, its distribution coverage falling below 1, and investors stepping back from the shares.
But all of this is in support of long-term growth. And Buckeye has been willing to support the distribution through periods like this before, as 2013 and 2014 show. It's also worth noting that 98% of the partnership's adjusted EBITDA through the first half of the year was fee-based. So Buckeye is a focused but fairly stable business. If history is used as a guide, once this period of investment passes and the VTTI deal starts to bear fruit, Buckeye's distribution coverage will get back above 1. And that 22-year streak will keep growing the whole time. (It's increased the distribution in each of the last three quarters, by the way.)
Grab it while you can
This suggests that the high yield offered by Buckeye today could be an opportunity. That said, as the comparison to lower-yielding Enterprise above shows, Buckeye is probably not appropriate for conservative investors. You need to be able to handle a little uncertainty if you own Buckeye, since management has been willing to let distribution coverage drop below one. But if you understand the business, management's commitment to growing the distribution over time, and what's going on today to build Buckeye for tomorrow, you might just find a place for this high-yield partnership in your portfolio.
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