A high dividend yield usually means one of two things. Either investors don't believe the company can sustain the payout, or the business has another factor creating some overhang. These issues will weigh down a company's valuation, pushing up its dividend yield.
Kinetik Holdings(NYSE: KNTK), Plains All American Pipeline(NASDAQ: PAA), and Western Midstream(NYSE: WES) all currently offer big-time payouts. Their high yields are due to a non-financial factor weighing them down (ownership quirks in these cases). That's causing investors to underrate and undervalue these companies.
Investing toward a big year
Kinetik Holdings came into existence in 2022 following the merger of Altus Midstream (backed by oil and gas producer APA Corporation) and EagleClaw Midstream (backed by private equity giant Blackstone and I Squared Capital). The deal created a pure-play midstream company focused on the Permian Basin.
APA, Blackstone, and I Squared still own most of Kinetik's stock, which has weighed on its valuation a bit. It's a big reason why the pipeline company's dividend yield is currently 8.8%. That's several times above the dividend yield on the S&P 500 (recently around 1.6%). The market remains worried that these owners will eventually look to unload their shares, potentially driving its price down even further.
That's causing investors to underrate the company and overlook its dividend. Kinetik generated enough cash to cover its payout by a comfortable 1.2 times during the first quarter. It also had a solid leverage ratio of 4.3 times. That gives it the financial flexibility to invest in additional expansion projects. It's investing $490 million to $540 million this year in projects, which set it up to grow earnings by 13% next year. It also paid $65 million to buy some midstream assets from its largest customer in a highly accretive deal. These and future investments will grow its cash flow, giving Kinetik more money to pay dividends.
Plenty of room to rise
Plains All American Pipeline currently yields 8%. One factor driving that high payout is the complex ownership structure of this master limited partnership (MLP). Plains GP Holdings owns a non-economic controlling general partner interest in the MLP and an indirect limited partner interest. That makes it one of the few MLPs that hasn't completed a consolidation transaction to eliminate having a separate general partner.
That complex ownership structure is putting some weight on Plains All American Pipeline's valuation since the market expects it will ultimately complete a consolidation transaction. The oil pipeline giant has also struggled with the impact of commodity price volatility in the past. Debt and that latter issue forced the MLP to slash its payout several times in the past.
However, the company has worked hard to reduce debt and shore up its financial situation. It achieved its targeted leverage ratio last year, which led it to establish a new multi-year capital allocation framework. Plains All American Pipeline increased its annual distribution rate by $0.20 per unit to $1.07 per unit. It also set a target of increasing its payout by $0.15 per unit each year until it reaches a coverage ratio of 160% of its cash flow. With expected coverage of around 215% this year, it still has ample room to grow the payout.
Enhancing the payout
Western Midstream is another pipeline company with an ownership overhang. Oil giant Occidental Petroleum still owns a majority stake in the company. While Occidental has been trimming its interest over time and Western operates as an independent company, this relationship weighs on its valuation. It trades at one of the lowest valuations in the sector.
That low valuation is a big reason the company offers a big-time yield. Western Midstream pays a base distribution of $2 per unit each year, giving it a yield of 7.4% at the recent price. In addition, the company made an enhanced distribution payment of $0.356 per unit in the first quarter, based on its strong balance sheet and 2022 results. While that enhanced payout might not be recurring in the future, it gives investors additional income upside potential.
Overlooked due to overhangs
Kinetik Holdings, Plains All American Pipeline, and Western Midstream don't get a lot of attention these days. The market seems to have dismissed them because of concerns that their largest investors could dump their investments in the future. That has weighed on their valuations. However, their low valuations have this trio offering ultra-high yields, something income-focused investors won't want to miss.
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Matthew DiLallo has positions in Blackstone. The Motley Fool has positions in and recommends Apa and Blackstone. The Motley Fool has a disclosure policy.
