Last year was both the best of times and the worst of times for Plains All American Pipeline (NYSE:PAA). The oil pipeline MLP delivered significantly higher earnings than expected in 2019 due to the strength of its market-sensitive supply and logistics (S&L) segment, which produced a gusher of cash thanks to dislocations in the oil market. Because of that, Plains All American’s full-year earnings were 18% above its initial guidance and 22% higher than 2018’s level.
The MLP’s unit price, however, has tumbled more than 30% over the past year. That’s due to the expectation that S&L results will normalize this year because new pipelines started up and oil market conditions have softened. That slump has pushed the yield on the company’s distribution up to around 9%. While that higher yield might seem higher risk, the company’s management team made it clear on the fourth-quarter call that the payout is on an increasingly sustainable foundation.
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Still solid amid a softer year
Plains All American Pipeline CFO Al Swanson spearheaded the discussion on the MLP’s financial profile. He stated:
At year-end 2019 we reported significant improvement in our targeted financial metrics relative to prior years and committed liquidity of approximately $2.5 billion. As we look to our 2020 guidance, despite growth in our fee-based business, we expect our financial metrics to compress and leverage ratios to increase as our S&L earnings normalize and as we complete our multiyear expansion capital program. Consistent with our targeted financing structure, we expect to fund 2020 capital through a combination of excess distributable cash flow, asset sales proceeds, and long-term debt.
As Swanson notes, Plains All American ended 2019 on excellent financial footing. The MLP’s leverage ratio at year-end was 2.8 times debt-to-EBITDA, which was well below the low end of its 3.0 to 3.5 times target range. Further, it generated enough cash to cover its high-yielding payout by a comfortable 2.17 times.
However, with its S&L earnings normalizing this year, the company expects leverage to rise and coverage to decline. Though given its current breathing room, it will remain within its comfort zone, with it projecting to cover its 9%-yielding payout by a still-comfy 1.57 times.
Because of that, investors don’t need to worry about the distribution even though 2020 and 2021 will both be heavy investment years for the company. CEO Willie Chiang discussed the MLP’s capital spending plans by stating:
With respect to our capital program, for 2020 and 2021 combined, we expect total expansion capital investment to be approximately $2.3 billion, excluding project financing. We currently estimate investing about $1.4 billion in 2020, followed by a meaningful reduction in 2021 to approximately $900 million … Importantly, we intend to fund the equity portion of our 2020 and 2021 expansion capital without issuing equity (i.e., selling more units). Looking forward, we do not have any material organic growth capital commitments beyond 2021, and we expect our capital program to be further reduced in 2022.
Plains All American intends to bridge the equity gap through a combination of retained cash after paying the distribution and $600 million of asset sales, two of which it already announced. Because it has the funding largely lined up, it does not need to consider reducing its high-yielding payout.
A gusher of excess is on the way
While 2020 will be a tighter year, Plains All American’s expansion program will start paying dividends next year. Chiang stated on the call that “we expect a step change in free cash flow improvement as we reduce our organic growth capital investments and the EBITDA benefit of these projects begins ramping up in 2021.” As that happens, its financial metrics should start improving again, which will enhance the long-term sustainability of its distribution.
Given this outlook, Plains All American believes it can keep increasing its payout. Both Chiang and Swanson confirmed on the call that the company hasn’t changed its guidance of growing its distribution by around 5% annually over the next couple of years.
Meanwhile, with increasing financial flexibility heading into 2022 as it benefits from several pipeline start-ups next year, the company will be in a position to return even more money to investors once it gets over the current hump. That could come in the form of accelerated distribution growth or a unit repurchase program.
Nowhere to go but up
Plains All American Pipeline expects 2020 to be a bit more challenging than last year because of the impact of weaker market conditions on its S&L business. However, it has such a huge financial cushion, it will have no problem funding its current slate of expansion projects, which will reaccelerate growth starting next year. Given this outlook, the company has the flexibility to continue increasing its high-yielding payout over the next two years, with the potential for an acceleration in 2022. That forecast makes it a compelling stock for dividend-focused investors like retirees to consider buying.
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