Go With The Flow: 3 Outperforming Energy Stocks Yielding 8-9% (NYSE:CEQP.PR)

Oil Refinery And Pipeline

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It has been a rough year for the market so far in 2022, with the S&P down nearly -25%. The one bright spot has been the energy sector, which is still the only sector with a positive return this year, up 35%:

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It took a long hiatus for energy investors see some sunshine from this sector – it lost ~70% of its overall value between Q3 2014 and Q4 2020. But, since the Q4 2020 lows, energy is up ~1.9X, and is within ~13% of its Q3 2014 highs.

The energy sector has traditionally been associated with higher yielding stocks and funds. Even with its decline over those six years, many income investors have hung onto their energy-related stocks, figuring that the sector would rise again at some point.

There are many different types of investments in this sector, but, if you’re looking for attractive high yields with more stability, you may want to check some energy-related preferred stocks.

We’ll look at three midstream energy preferred stocks in this article:

-Crestwood Equity Partners 9.25% Preferred Units (NYSE:CEQP.PR)

-DCP Midstream LP 7.875% Preferred Shares Series B Units (NYSE:DCP.PB)

-DCP Midstream LP 7.95% Preferred Shares Series C Units (NYSE:DCP.PC)

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The CEQP.PR units have more investor protections than your average preferred shares, having been part of a Crestwood merger deal back in 2015. The preferred units are entitled to a cumulative distribution of $0.2111/quarter.

However, if Crestwood fails to pay the Preferred Distribution in full in cash, then until such time as all accrued and unpaid Preferred Distributions are paid in full in cash, the Distribution Amount will increase to $0.2567 per quarter. Crestwood won’t be permitted to declare or make any distributions in respect of any Junior Securities (including the common units) and, subject to certain exceptions, certain preferred unitholders will receive the board designation rights.

If a Change of Control occurs, a preferred unitholder can require Crestwood to redeem its preferred units at a price of $9.218573/preferred unit, plus accrued and unpaid distributions to the date of such redemption.

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The DCP.PB and DCP.PC units also are cumulative, but with a future floating rate feature, which begins on 6/15/23 for the B units:

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DCP.PC units’ floating rate begins on 10/15/2023. Both units have no maturity date.

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Dividends:

As of the 10/13/22 close, the CEQP.PR units had the highest yield, at 9.54%, with Distributable Cash Flow, DCF Preferred coverage of 5.26X over the most recent 4 quarters.

The two DCP preferreds yield a bit less, at 8.53% for the C units, and 8.18% for the B units, but DCP’s preferred dividend coverage is much higher than CEQP’s. All 3 stocks pay quarterly.

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The floating rate for the DCP B units is 491.9 basis points above 3-Month LIBOR. The 3M LIBOR rate is 3.94%. If that’s the rate on 6/15/2023, investors buying at $24.08 would receive a 9.20% yield on the B units at that time.

The B units have a 488.2 basis point future floating rate above 3-Month LIBOR, which gives them a higher 9.46% equivalent future yield on 10/15/23, based on their 10/13/22 $23.32 price.

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Could these floaters be called? Definitely maybe.

That depends upon whether DCP’s management can find alternative ways of financing growth before the call dates. With the prime rate at 6.25%, and likely to rise before these call dates, the spread between refinancing rates and these preferred future floating rates may not be as wide as it once was.

However, DCP is generating a great deal of excess free cash flow, so management may possibly use some of that $ to redeem the preferreds.

A redemption for DCP-B on 6/15/2023 would result in a $2.40/unit net profit, comprised of a $.92 capital gain, and $1.4775/unit in pre-call distributions, for a total return of 9.96% in ~8 months, or 14.8% annualized.

A redemption for DCP-B on 10/15/2023 would result in a $3.67/unit net profit, comprised of a $1.68 capital gain, and $1.99 in pre-call distributions, for a total return of 15.74%:

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Distribution Coverage:

DCP had major Distributable Cash Flow growth in Q1-2 ’22, which caused its preferred distribution coverage to soar, from 14.79X in Q1-2 ’21, to 25.34X in 2022. Looking back further, DCP had 15X-plus preferred coverage in 2020 and 2021, and has trailing coverage of 26.28X over the most recent four quarters:

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CEQP had more modest DCF growth so far in 2022, but still had good preferred distribution coverage of 5.43X in Q1-2:

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Taxes:

Unitholders receive a K-1 report at tax time for all three of these preferreds.

Earnings:

CEQP has had outstanding revenue growth over the past six quarters, up 103% in 2021, and 54% in Q1-2 ’22, due to its acquisitions and organic expansion projects being put into service.

Net income, which includes several non-cash expenses, the major one being depreciation and amortization, is often very lumpy for midstream firms. Net Income bounced back in Q1-2 ’22, hitting $41M, vs. a -$96.8M loss in Q1-2 ’21.

Adjusted EBITDA is up over 13% so far in 2022, and Distributable Cash Flow, DCF, is up 15.76%. Interest Expense is up ~7%, due to more assets to finance.

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DCP also had major topline growth in full year 2021, up 70%, and so far in 2022, up 74%. Net income was minimal in Q1-2 ’21, at just $22M, but surged to $463M in Q1-2 ’22.

EBITDA and DCF growth were modest in full-year 2021, but rose 50% and 76,5% respectively in Q1-2 ’22, due to record results for adjusted EBITDA, DCF, and excess FCF in Q2 ’22.

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DCP’s G&P segment provides the lion’s share of adjusted gross margin, while the Logistics & Marketing segment accounted for ~6% in Q1-2 ’22.

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DCP site

CEQP’s Gathering & Processing North segment is by far the largest, with 70% of estimated 2022 EBITDA, with the G&P South segment at 20%, and the Storage & Logistics segment at 10%.

Management is allocating 55% capex to G&P North, 40% to G&P South, and 5% to the S&L segment. Much of CEQP’s 2022 capital program is centered around integrating Crestwood’s legacy systems with many of its newly acquired assets.

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CEQP site

Growth Projects:

DCP completed its James Lake acquisition in August ’22. This new Permian Basin asset was acquired for $160M at an attractive 5.5X EBITDA multiple, and is expected to be immediately accretive:

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DCP site

Following on its 2021 acquisitions, CEQP has several more growth projects in the works for 2022 in each of its segments, with the Williston Basin getting ~$115M in capex, and the Delaware Basin getting $90M, while the Powder River and NGL assets are getting ~$5 to $10M.

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CEQP site

Profitability and Leverage:

DCP’s ROA and ROE figures are much higher than CEQP’s, while its debt leverage is much lower, and its interest coverage is higher. Both firms have similar EBITDA margins.

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Debt:

DCP’s management has reduced debt by over $300M so far this year, delevering at a rapid pace, going from 4.2x to 2.9x over the last 12 months. That has resulted in upgrades from Fitch to investment grade and from S&P to a positive outlook. Standard & Poor’s rates DCP’s debt as investment grade, with a BBB- rating, while Moody’s rates it BA3, non-investment grade.

CEQP’s management has been working on decreasing CEQP’s debt leverage over the last two years, and has made some inroads, with its figures showing a decline from 4X at 12/31/20, to 3.7X as of 6/30/22. CEQP has no debt maturities until 2025, when its 5.75% Notes come due.

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CEQP site

Performance:

All three of these preferred units have outperformed the S&P on a price basis over the past month, quarter, year, and so far in 2022. Adding distributions into the mix shows DCP-B with the best one-year total return of 4.88%, followed by DCP-C at 2.85%, and CEQP.PR at -1.25%, vs. -16% for the S&P 500.

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While CEQP.PR doesn’t have a specific call date, a change of control could force the company to redeem these units at ~$9.22. At $8.85, they’re 4% below that figure, and 6.6% above their 52-week low.

The DCP-B units are 3.68% below their $25.00 call value, and 11.5% above their 52-week low, while the DCP-C units are 6.72% below their $25.00 call value, and ~4% above their 52-week lows:

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Parting Thoughts:

As you can see from the performance table, these preferreds haven’t kept pace with the energy sector’s big price gains so far in 2022, but that’s typical of preferreds – they generally are much less volatile than common stocks are. We rate them a long-term buy.

If you’re interested in other high yield vehicles, we cover them every Friday and Sunday in our articles.

All tables by Hidden Dividend Stocks Plus, except where otherwise noted.

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