The Safety Net: An Almost Perfect Opportunity

Marc Lichtenfeld By Marc Lichtenfeld
Chief Income Strategist, The Oxford Club

Dividend Investing

A yield over 6%, a cash distribution that will far outpace inflation, a track record of raising the dividend – it sounds like the perfect dividend stock.

It is… except for one small – but important – wrinkle. The company generates less cash than it used to.

Williams Partners (NYSE: WPZ) is a master limited partnership (MLP) that is majority-owned by parent Williams Companies (NYSE: WMB). While the parent pays a respectable 4% dividend yield, the MLP pays a much higher 6.6% yield. Better yet, the payout will go above 7% this year if the company gets its cash-generation machine back on track.

Williams Partners owns pipelines across the United States. Its most important asset is the 9,800-mile Transco pipeline, which runs from the Gulf of Mexico to the New York metropolitan area. It also owns pipelines in the Northwest, and is a dominant player in the important Marcellus region.

Taking a Toll

Pipelines are a great business because, other than the initial expense of building the pipeline, there are not a lot of other costs. Once the pipeline is up and running, an MLP acts like a toll booth, charging oil and gas companies to use its pipes.

As a result of these “tolls,” pipeline companies generate a lot of cash – most of it is returned back to unitholders. (Remember, MLP investors own units not shares.)

Last year, Williams Partners handed $1.44 billion back to unitholders. That’s $3.31 per unit. Based on today’s price, it’s a yield of about 6.6%.

But the company’s $1.49 billion of distributable cash flow (DCF), a measure of how much cash is available for distribution to unitholders, fell by 9.7% due to low natural gas prices and shrinking margins.

For an income investor, those numbers are a scary sight. We never want to see cash flow falling when we’re depending on it for a distribution.

However, Williams Partners’ management has issued guidance for 2013 and 2014. It expects a strong return to positive growth as new projects come online.

In 2013, management projects DCF to be in the range of $1.625 billion to $1.975 billion, with a cash distribution of $1.962 billion to $2.073 billion.

Now, you may think I have those numbers reversed… But I don’t.

In 2013, management expects to pay out more in cash distributions than it takes in from its business.

That can’t be sustained.

Fortunately, management doesn’t expect the trend to last.

Making Big Promises

In 2014, DCF guidance is for $2.27 billion to $2.68 billion, while the cash distribution is projected to be $2.37 billion to $2.51 billion.

Furthermore, management told unitholders to expect 9% growth in the cash distribution this year and next year. Should Williams lift the distribution per unit by that amount in the next year, the yield on today’s share price would rise to 7.1%.

The issue is whether the company will actually be able to raise DCF enough in 2014. If things don’t get better in 2013 or remain slower than expected, the company may not be able to grow the distribution or even sustain it at current levels.

But I don’t expect that to be the case. With new projects about to come online and starting to generate cash, Williams Partners should, at the very least, come close to meeting its goals. Nonetheless, the risk of missing expectations is a risk you should be aware of.

A few things give me confidence that Williams Partners will have its cash flow and distribution situation ironed out by next year.

First is the fact the company has a nine-year track record of yearly dividend hikes. That shows me management can operate in a variety of economic climates.

The second confidence builder is the company’s announcement of 9% growth in its distribution.

Managements can issue earnings guidance and miss. It happens a lot. And when it does, the stocks get hit and the executives move on to the next quarter. But when expectations are set for a dividend and management fails to deliver, well, the stock gets crushed and members of management are often out of a job.

Cutting a dividend or failing to live up to expectations is not something any management team takes lightly. So if they’re going to set the bar high by announcing projected growth in the distribution, they do it with a high level of confidence.

Williams Partners will not have an obstacle-free run on the way to dividend growth over the next two years – the low prices of gas will continue to crimp margins. But I expect management to deliver what it promised.

Dividend Safety Rating: B

As always, if you’d like me to review the dividend safety of a particular stock, leave the ticker symbol in the comments section below.