DCP Midstream Partners: The ~12% Dividend Yield Is Too Juic…

DCP Midstream Partners: The ~12% Dividend Yield Is Too Juic…


Introduction

DCP Midstream LP (DCP) is a Fortune 500 MLP based in Denver, Colorado, with a diversified portfolio of gathering, processing, logistics and marketing assets that presents a compelling investment opportunity, especially for income-oriented investors, as it has a ~12% dividend yield that is well-covered, and has upside potential due to its project pipeline over 2020. DCP is one of the largest natural gas liquids producers and marketers, and one of the largest natural gas processors in the U.S. with 62,000 miles of pipeline, 60 processing plants and 1,450 MBpd gross NGL pipeline capacity. The owner of DCP’s general partner is a joint venture between Enbridge (ENB) and Phillips 66 (PSX).

(Source: December 2019 Investor Presentation)

DCP has had poor performance the past 6 months, falling to as low as $21/share as of early December 2019, falling ~52% from May 2019, and currently has a 12% TTM dividend yield with its $0.78/share distribution paid quarterly. The dividend is covered 1.20x with management expected 2019 DCF. It is also noted that that DCP has a strong 14.7% DCF yield using 2019 annualized DCF.

ChartData by YCharts

The stock price decline is likely a result of the steep decline in natural gas prices since January 2019. However, DCP share price has been impacted much greater than its NGL midstream counterparts and is much cheaper, as shown below.

ChartData by YCharts
ChartData by YCharts

Company Ticker Market Capitalization (Billions) EV (Billions) EV/EBITDA Yield
DCP Midstream DCP $5.1 10.5 8.75x 12.34%
Enterprise Products Partners L.P. EPD $62.04 90.49 11.70x 6.25%
Magellan Midstream Partners MMP $14.08 18.86 14.34x 6.59%

(Source: Author’s Tables)

This is likely due to the fact that EPD and MMP’s gross margins are ~85% fee-based, while DCP’s are 65% fee-based, which on the surface would indicate that 35% of their margins are exposed to commodity prices, which would partially explain why it is so “cheap.” However, 13% of the commodity price exposure is hedged, indicating that only 22% of gross margins are actually exposed to commodity prices. This is still greater commodity price exposure than most MLPs; however, DCP is targeting an 80% fee and hedged target for 2019, and projects 70% fee-based gross margins for 2020. 2019/2020 growth projects are ~90% fee-based and are expected to add ~$270 million to adjusted EBITDA, which makes this 12% dividend yield opportunity look all the more juicy.

(Source: December 2019 Investor Presentation)

The Business

DCP operations are divided into two segments, Logistics & Marketing and Gathering & Processing, and the company’s adjusted EBITDA generation is about evenly split between the two units, with L&M contributing $564 million to adjusted EBITDA through 9 months of 2019 and G&P contributing $545 million.

This is a significant improvement in business evolution since 2010, in which the G&P segment accounted for 90% of adjusted EBITDA and which tends to be a less “fee-based” segment.

As we can see, DCP’s operations are not as diversified as those of some other midstream companies. Its operations are concentrated around the Permian, Midcontinent and DJ basins. This may not necessarily be a problem, as it still has exposure to the Permian basin, which is likely to be the primary driver of U.S. production growth over the next few years, as well as the natural gas-rich DJ basin.

Logistics & Marketing

DCP markets NGLs, residue gas and condensate and provides logistics and marketing services to third-party NGL producers and sales customers in the United States. This includes purchasing NGLs on behalf of third-party NGL producers for shipment on NGL pipelines and resale in key markets. NGL services include plant tailgate purchases, transportation, fractionation, flexible pricing options, price risk management and product-in-kind agreements, and operations are located in close proximity to the company’s Gathering and Processing assets in each of its operating regions.

DCP’s pipelines provide transportation services to customers primarily on a fee basis. Therefore, the results of operations for this business are generally dependent upon the volume of product transported and the level of fees charged to customers. The volumes of NGLs transported on DCP’s pipelines are dependent on the level of production of NGLs from processing plants connected to NGL pipelines.

DCP’s Logistics & Marketing segment is currently engaged in a few growth projects that will both help to support the production growth of the basins in which it operates, as well as the DCF growth of the segment. One of the most significant of these projects is the Gulf Coast Express pipeline, which extends from the Permian basin to the Gulf Coast. The Gulf Coast Express pipeline was placed in service in September 2019, adding ~2.0 Bcf/d of gas takeaway from the Delaware Basin. DCP owns a 25% equity interest in the pipeline, but is operated by Kinder Morgan (KMI).

Another project that DCP’s L&M segment is working on is the Southern Hills pipeline. This pipeline is designed to transport natural gas liquids from the Midcontinent basin, where they are pulled out of the ground to the massive fractionation facility at Mont Belvieu. The Southern Hills is expected to expand capacity from ~190 to 230 MBbls/d and to be in service by the fourth quarter of 2020.

Other growth opportunities:

  • FERC approval for the Cheyenne Connector was received in September, and DCP exercised an increased 50% ownership option in October. The pipeline is expected to be in service in the first half of 2020, alleviating constraints in the DJ Basin.
  • DCP is adding new NGL takeaway to the DJ Basin with the Southern Hills pipeline extension, via the White Cliffs conversion. The initial capacity is expected to be 90 MBbls/d, expandable to 120 MBbls/d, with an anticipated fourth-quarter 2019 in-service date.
  • Expansions of Front Range and Texas Express will add incremental NGL takeaway from the DJ Basin. The Front Range pipeline is expected to ramp to 255 MBbls/d of capacity in 2021, and the Texas Express pipeline is expected to ramp to 330 MBbls/d of capacity in 2022.

Gathering and Processing

The G&P segment consists of a geographically diverse complement of assets and ownership interests that provide a varied array of wellhead to market services for producer customers in Alabama, Colorado, Kansas, Louisiana, Michigan, New Mexico, Oklahoma, Texas and Wyoming. These services include gathering, compressing, treating, and processing natural gas, producing and fractionating NGLs, and recovering condensate. The G&P segment’s operations are organized into four regions: North, Permian, Midcontinent and South.

The geographic diversity helps to mitigate natural gas supply risk so that DCP is not tied to one natural gas resource type or producing area. Assets are positioned in certain areas with active drilling programs and opportunities for organic growth. DCP provides producer customers with gathering and processing services that allow them to move their raw (unprocessed) natural gas to market. Raw natural gas is gathered, compressed and transported through pipelines to processing facilities. In order for the raw natural gas to be accepted by the downstream market, they remove water, nitrogen and carbon dioxide and separate NGLs for further processing. Processed natural gas, usually referred to as residue natural gas, is then recompressed and…

Moving & Transportation Services CEO Jonathan Cartu

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