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Dividend Death Watch Update

Try to imagine a zebra without stripes, Thanksgiving without turkey, or a pair of Nike’s without the iconic “swoosh.”

Of course, it’s nearly impossible to envision certain things without their distinguishing characteristics.

Which is why a master limited partnership (MLP) without a distribution is such a strange entity. These tax-advantaged vehicles were basically created to provide yield – the more the better.

But MLPs like Breitburn Energy Partners LP (BBEP), once coveted by yield hogs for their high payouts, have become a slow-motion train wreck within the financial markets.

Just last month, Breitburn suspended its distribution, thus joining Linn Energy, LLC (LINE) as the second member of my Dividend Death Watch to go yield-less.

Here’s an update on this list of securities with dividend/distribution sustainability issues:

Dividend Death Watch Update

As you can see, their performance has been abysmal. In just under a year, the average return is -50% (distributions included but not reinvested).

A few of the MLPs have continued to increase their distributions. Enbridge Energy Partners, LP (EEP), for instance, has increased its distribution by 2% this year. MarkWest Energy Partners, LP (MWE), which merged with MPLX LP (MPLX) on Friday, has hiked by 3%.

Sunoco Logistics Partners LP (SXL) has increased its payout the most of any security on the list. However, over the last four quarters, operating cash flow – never mind free cash flow – has been insufficient to cover cash distributions. This shortfall is partly due to the 19% increase in the number of units (shares) outstanding this year, which increases the amount of cash being distributed.

The management of SXL seems to have a dividend death wish.

ONEOK Partners, LP (OKS) and Williams Partners LP (WPZ) have held their payouts steady in 2015. This is interesting because both previously had long strings of distribution increases.

Vanguard Natural Resources, LLC (VNR) and Legacy Reserves LP (LGCY) have both slashed their distributions, rightfully earning their places near the top of the list.

Diamond Offshore Drilling, Inc. (DO), the only common stock listed, eliminated its special dividend in February 2015.

Atlas Pipeline Partners, LP (APL) was acquired by Targa Resource Partners LP (NGLS) in March 2015.  Yes, these partnerships will continue to buy each other in an attempt to hide the fact that they’re dying.

Finally, it’s worth noting that the shares of Kinder Morgan, Inc. (KMI) have come under significant pressure lately, and its 4.3% bonds due 2025 have declined from above $100 earlier this year to below $85.

Kinder Morgan is no longer an MLP, but it’s still an industry bellwether.

The End Game

Investors are still missing an important point. When the cost of capital spikes, capital-intensive businesses suddenly have a big problem.

A company can reduce this risk by issuing debt and locking in a borrowing rate. However, if it’s already highly levered, issuing more debt simply hastens eventual liquidity problems. Also, if the company’s bonds are in free fall, then it’s too late.

This precipice is where many energy companies find themselves today.

And don’t expect a rebound in the price of crude oil to come to the rescue, either. We have oil coming out of our ears and storage capacity is running out.

Ultimately, the overinvestment and excessive leverage in the energy sector will end in tears.

By this time next year, we’ll witness further distribution cuts and suspensions… as well as defaults!

Once a major MLP default occurs, true panic will pervade. At that point, we’ll be better able to assess which players will survive the massacre.

Safe (and high-yield) investing,

Alan Gula, CFA