This High-Yield Stock Just Gave Its Investors a Monster 20% Raise

Plains All American Pipelines (NYSE: PAA) has been on a mission. The oil pipeline master limited partnership (MLP) has been working hard over the past few years to shore up its financial profile so it can return even more cash to investors above its already generous 4.9%-yielding distribution. Those efforts have paid off as the company recently achieved its financial targets. That allowed the pipeline company to give its investors a 20% raise for 2019, boosting the yield to 5.9%.

Meanwhile, the company expects that it will be able to continue giving investors a raise over the next few years. Further, it sees its financial foundation growing even stronger as it aims to retain more cash in the near term to fund expansion projects. That combination of financial strength and visible growth makes it an ideal option for income-seeking investors.

A rock-solid strategy

In August of 2017, Plains All American unveiled plans to shore up its financial foundation, which had weakened considerably due to the impact of the oil market downturn that started in late 2014. One of the actions it took was to slash its payout -- its second cut in a year -- so it could retain more cash to fund expansion projects and pay down debt. The company aimed to reduce borrowings by $1.4 billion to lower its leverage ratio from an elevated 5.1 times to a more comfortable range of 3.5 to 4.0 times by early 2019.

The company achieved its leverage target by ending last year at 3.4 times debt to EBITDA. Because of that, it was only a matter of time before the company boosted its dividend -- the last question remaining was by how much. While the company could have easily afforded a bigger raise, it opted for a 20% increase, which will consume about 57% of its cash flow, or a 1.76 times coverage ratio. That lines up well with leading MLP Enterprise Products Partners (NYSE: EPD), which has targeted a similar payout ratio. It's also well above its long-term target of 1.3 times.

There's more growth coming down the pipeline

Plains All American opted to retain more cash flow so that it could further improve its balance sheet. The oil pipeline company is now targeting a leverage ratio between 3.0 and 3.5 times. That too lines up with the more conservative targets of pipeline companies these days as Enterprise Products Partners, for example, has reduced its leverage goal from 4.0 times to 3.5 times.

Over the next couple of years, Plains All American plans to allocate its excess cash after paying its current distribution across the following four priorities in this order:

  1. Leverage reduction to achieve its lower targeted metrics.
  2. Disciplined capital investment in high-return expansion projects that should steadily grow cash flow.
  3. Distribution growth, with it aiming to increase its payout by around 5% annually over the next couple of years.
  4. A unit repurchase program, depending on market conditions.

What's worth noting is that Plains All American has made further reducing leverage a priority as opposed to returning more cash to investors via a repurchase program. That differs from Enterprise Products Partners' approach, which saw that company initiating a $2 billion repurchase program earlier this year. That's due in part because Enterprise Products Partners already has the highest credit rating among MLPs. Plains All American hopes that by further reducing leverage, credit rating agencies will upgrade it to Enterprise's level.

However, even after the company achieves that stronger financial profile, Plains All American expects "distributions and distribution growth to be our primary method of returning capital to investors," according to CFO Al Swanson, not a repurchase program. That suggests the company could reaccelerate distribution growth in the future since it aims to eventually pay out around 75% of its cash flow.

A great income growth stock for the long term

Plains All American Pipeline's turnaround plan has proven to be highly successful. Because of that, it's starting to return more money to investors via a big-time raise in 2019. While the company does expect more moderate increases over the next couple of years as it works toward having a top-tier balance sheet, growth appears poised to reaccelerate once it achieves that goal. That makes it an appealing option for income-seeking investors since it offers them low risk, a high yield, and high growth potential over the long term.

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Matthew DiLallo owns shares of Enterprise Products Partners. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.