This High-Yielder Pays 11%

When many investors see a double-digit yield on an energy company, they think it’s a mirage.

Their skepticism is understandable.

There is no shortage of investors who’ve been lured in by the siren song of yield only to subsequently be smashed against the rocks when the dividend (or more aptly, the distribution) has been cut.

Master limited partnerships, in particular, have disproportionately smashed income portfolios. Linn Energy (NASDAQ: LINE) is both an example and one of many cautionary energy-income tales.

[ad#Google Adsense 336×280-IA]Linn is a U.S.-based oil and gas driller.

As recently as October 2014, it offered a $2.88 annual payout, which yielded 11.5% on the $25 unit price that prevailed at the time.

Today, that same $25 investment yields 4.8% after Linn cut its distribution 58% to $1.20 per unit beginning in January.

It gets worse.

That $25 Linn investment is no longer worth $25; it’s worth roughly $3.

So that means Linn now yields 40% based on the $1.20 distribution? Hardly. You can be sure as night follows day, a distribution cut is in store. There is no such thing as a real 40% yield.

Don’t be too skeptical, though. A real 11% dividend yield in energy exists, and it’s found in Calumet Specialty Products Partners (NASDAQ: CLMT), a fuel refiner and a manufacturer of specialty hydrocarbon products. Specifically, Calumet refines oil into gasoline, diesel, jet fuel and heavy oils. It also manufactures a wide range of customized lubricants, mineral oils, solvents and waxes.

In short, Calumet is no high-yield plugger. It doesn’t simply extract oil from the ground and then sell it at the going market price. Calumet adds value to the raw commodity, and that’s key. It creates sufficient value in many of its products so that it can demand a price instead of merely taking one.

But as they say, once bitten, twice shy. After all, you want to minimize the number of times you’re smashed against the rocks after chasing a mirage yield. But at the same time, you want to capture the real thing when the opportunity arises.

Of course, we’re talking investing – there are no guarantees – but history and reasonable analysis suggest Calumet is a high-yield energy partnership with staying power. Calumet has maintained its $2.74-per-unit annual distribution through the hard selloff in oil that began last year. Before the oil-price disruption, Calumet regularly increased its distribution.

Recent financial performance points to Calumet maintaining its distribution into at least the relevant future. The partnership reported strong financial numbers for the second quarter. Because Calumet is organized as an MLP, cash is the focus.

Calumet’s adjusted EBITDA increased to $95 million compared to $39.3 million in the year-ago quarter. More important, Calumet generated distributable cash flow (the source cash for the distribution) of $73.3 million compared to a $15 million shortfall last year. This go around, the distribution was easily covered 1.3 times. Calumet targets a 1.2 to 1.5 coverage ratio.

Expect Calumet’s cash-flow stream to rise in the coming year. Recent investments in specialty production facilities in Missouri and San Antonio are expected to contribute an additional $28 million to $32 million in EBITDA beginning next year. The expansion of its Montana refinery, expected to be completed in the first quarter of 2016, is expected to contribute another $70 million to $90 million in EBITDA annually.

What’s more, the recent pullback in oil prices should help more than harm. Calumet’s specialty-fuel margins are expected to widen because of lower feedstock. Overall refining margins should also improve due to an increase in the gasoline crack spread (the difference between the price of oil and the gasoline refined from it).

Believe your eyes. Calumet’s 11% distribution yield is real, in contrast to the many enticing high-yield energy distributions that aren’t.

— Steve Mauzy


Source: Wyatt Investment Research