It may be too early to tell whether other master limited partnerships (MLPs) in the midstream sector will follow suit.
But Kinder Morgan's (KMI) decision to slash its dividend by three-quarters last week sends a strong signal on how the industry may try to cope with a prolonged era of low commodity prices, ratings agency Standard & Poor’s (S&P) said in a note.
“This latest move by KMI, an industry leader, highlights the precarious position some midstream companies find themselves in today – the stark reality of managing large capital spending programmes, with sub-1x distribution coverage ratios, equity prices at multi-year lows, and limited capital market access,” S&P credit analysts wrote.
From a credit perspective, the ratings agency viewed KMI’s decision favorably since it will save $3.8 billion in annual dividends, eliminating the need for the company to raise additional equity.
The group’s stock price also benefitted, with a 6 percent increase the day after the dividend cut was announced. This “relieved a level of market uncertainty,” according to S&P.
While a dividend cut can help maintain a company’s financial flexibility and credit quality, it is a tool of last resort since MLPs are usually created for the substantial cash flow they typically generate for their owners.
Other tools MLPs are more likely to use before deciding to cut dividends include issuing hybrid securities, instituting incentive distribution right (IDR) givebacks, scaling back on capital spending or participating in joint ventures.
S&P notes that most companies are in the process of executing growth programmes that were conceived in 2013/2014, when the price of oil was more than $100 per barrel.
“If commodity prices don’t recover, some midstream companies, in our opinion, could follow KMI’s lead and eventually choose to cut distributions to reset their business model to take into account $35 to $45 oil based on the current forward strip over the next few years.”
Sustained low commodity prices are also expected to delay new MLP listings, according to the ratings agency.