Martin Midstream Partners (NASDAQ: MMLP) is one of the highest-yielding MLPs around these days. With a current yield of 14.7%, it’s almost double the MLP average. While there are several above-average yielders worth considering these days, this isn’t one of them.
Drilling down into the numbers
Last year, Martin Midstream Partners managed to cover its high-yield payout with cash flow by 1.18 times. That’s a comfortable level for an MLP and an improvement over the slightly less than 1.0 times coverage it had in the previous three years. This year, however, will be a different story. While the company expects to generate about $156.1 million in adjusted EBITDA, nearly flat with 2017, cash flow will fall because the company plans to spend more money maintaining its assets. After spending just $18.1 million in maintenance capital last year, the company sees that number climbing to $29.3 million in 2018, due mainly to $10.5 million in one-time projects. As a result, the company only expects to generate enough cash to cover its current payout by a razor-thin 1.0 times. For comparison’s sake, stronger MLPs like Magellan Midstream Partners (NYSE: MMP) typically keep that level above 1.2 times.
Martin Midstream’s coverage ratio wouldn’t be quite so concerning if the company generated rock-solid cash flow, had a strong balance sheet, and didn’t also have a hefty expansion program to finance. However, that’s not the case. While Martin Midstream operates several assets that generate stable fee-based cash flow, only 61% of its total comes from these steadier sources, with the rest earned from margin-based activities, which are less predictable. Most MLPs like to get 90% or more of their earnings from predictable sources like fee-based contracts — which was Magellan’s level last year — because it reduces cash flow volatility.
Martin Midstream’s balance sheet is also a concern after ending last year with a debt-to-adjusted EBITDA ratio of 5.11 times. For perspective, most MLPs like to keep that number around 4.0 times, though Magellan Midstream is one of the stronger ones considering its leverage ratio has averaged less than 3.5 times in recent years. Another of Martin Midstream’s concerns is that the company borrowed $445 million of the $664.4 million available to it under its revolving credit facility, leaving it with limited liquidity and causing its credit metrics to bump dangerously close to its financial covenants. Because of that, the company asked its banks to amend some of those covenants so that it could finance an upcoming growth project.
Is there any hope for this payout?
Making Martin Midstream’s already tight financial situation even worse is that the company expects to spend roughly $50 million in expansion capital in 2018, which is about double last year’s level. Driving the increase is the expansion of West Texas LPG, which is a joint venture with ONEOK (NYSE: OKE). The companies expect to spend $200 million on the project, with ONEOK paying $160 million given its 80% stake in the venture, leaving Martin Midstream with having to fund $40 million of the project. ONEOK expects to finish this project in the third quarter, which should provide a noticeable boost to earnings on the system. In Martin Midstream’s case, its share of the profits will rise from $5.3 million last year to $8.5 million in 2018. Earnings on the system should head even higher next year as it benefits from a full year of operations as well as a continued volume ramp.
While those incremental earnings will help improve Martin Midstream’s coverage and leverage metrics, the company has a long way to go before its numbers rival those of Magellan or ONEOK, with the later also boasting 1.2 times dividend coverage and recently achieving its leverage target of about 4.0 times. Because of its much weaker metrics, there’s a high risk that Martin Midstream will eventually need to reduce its high-yield payout to get its numbers to a more sustainable level.
Not worth the risk
Martin Midstream’s near 15% yield might look tempting, but it likely won’t last since the company’s financial metrics can’t support a payout of that size. That’s why I wouldn’t touch it because there is a high probability that the company will need to significantly reduce the distribution to get its financial metrics back on solid ground. Instead, investors are much better off considering lower yielding, but much less risky options such as Magellan or ONEOK, which both still offer attractive payouts of more than 5% these days.
