What’s Up With Breitburn Energy Partners’ 10% Dividend Yield? Our Man Looks Under the Rocks
In a world of diminishing interest rates, Breitburn Energy Partners (BBEP) offers investors starving for income an appealing dividend yield of 10%, almost 350 basis points more than what’s being offered by the average junk bond fund. Though management says the dividend is secure, sufficient red flags do exist to suggest that the oil and gas producer is paying distributions in excess of sustainable profitability.
BreitBurn Energy is a master limited partnership (MLP) focused on the upstream exploration and development of oil and gas properties. Unlike a traditional energy company, such as Exxon Mobil (XOM), but similar to an oil & gas royalty trust, such as Permian Basin Royalty Trust (PBT), an MLP technically has no employees and is required to pay out essentially all operating cash as dividends (or return of capital). However, oil & gas royalty trusts – unlike MLPs – are not acquisition-oriented and have finite lives (cash flow of proved reserves) and are more of a “pure bet” on commodity prices (little to no hedging activities).
As of December 31, 2011, Breitburn Energy’s total estimated proved reserves were 151.1 million barrels of oil equivalent (MMBoe), of which approximately 65% were natural gas and 35% were crude oil. Although the company has projects in seven states, about 50% of its reserves are concentrated in mature Antrim Shale acreage in Michigan. Additionally, though these wells have, on average, proven reserve life of 20–plus years, 93% of these hydrocarbon assets are natural gas.
Given the disparity in wellhead pricing between oil and gas, the company has increasingly redirected capital expenditures to more promising crude prospects. In 2012, $407 million has already been spent to acquire additional proven reserves of 19 MMBoe.
In addition, believing it can capitalize on attractive growth opportunities in legacy oil assets in California and newly purchased properties in the Permian Basin, Texas, and the Big Horn Basin in Wyoming, the company has upped its 2012 capita; expenditure budget to $152 million, from $68 million. Based on the revised spending program, management is forecasting 2012 production to increase year-on-year about 20% to 8.45 MMBoe.
Contrary to management’s optimistic guidance, an assessment of the company’s recent financials strongly suggests Breitburn Energy cannot continue to simultaneously fund day-to-day operations, cap-ex, interest payments and dividend distributions with cash flow from its operations. Fundamental weaknesses include falling net income and free cash flow, lower return on equity, and increasing debt leverage.
To some extent, the company has mitigated crude oil and natural gas price fluctuations with an active hedging program: In 2013, 78% of anticipated production has already been contracted, with oil and natural gas volumes fixed at $92.80 per barrel and $5.96 per mmbtu. The downside to this “price protected” portfolio is an ugly – and unspoken – truth at Breitburn Energy: cash flow growth is dependent on hitting the production target, which in turn, is tied to spudded wells and acquisitions, funded with more and more debt and by secondary stock offerings, which increases the amount of units outstanding and subsequent cash distributions paid out, too! Common units outstanding have grown by more than 35% in the last 18 months to approximately 73 million shares.
The dividend seems unsustainable, given current operating conditions. If management doesn’t willingly cut the payout, financial covenants on some $800 million in senior notes could force their hand. Specifically, if the ratio of earnings to fixed charges (interest and financing costs for the most recently ended four full quarters) drops below 2.25 to 1.0, the holders of this debt can demand either a restriction or suspension of cash distributions to unit holders. In the first nine months of 2012, Breitburn Energy has paid out approximately $97.25 million; net income attributable to the MLP during this period was a loss of $73 million.
Investors looking for better returns than the 1.61% yield currently being offered on 10-year U.S. Treasury notes – yet unwilling or unable to stomach the risk concomitant with an oil & gas MLP like Breitburn Energy – might look to the common stock of integrated energy giants. U.S.-based ConocoPhillips (COP), France’s Total SA (TOT), and Norway’s Statoil ASA (STO) for example, all have investment-grade credit ratings and offer attractive dividend yields of 4% or more.
David J. Phillips is a contributing editor at YCharts.