Stick Income In Your Pipe(line) And Smoke It

Co-produced with Treading Softly

When I was younger, we had a lot of colorful and creative ways to tell each other to face reality or to accept hard truths.

Perhaps you know some of the more popular ones like:

• Wake up and smell the coffee/roses
• Stick that in your pipe and smoke it!

One is aimed at someone needing to wake up to the realization that their problems need real-world solutions. The other is the demand that the listener simply accepts what was said whether they like it or not.

I love to adapt idioms to investing. Previously, we’ve suggested people should “wake up and smell the cash flow”. Sniffing out a company’s cash flow is the key to having long-term sustainable dividends.

One thing I love about Seeking Alpha is the exchange of ideas and the passionate debates over ideas you can find in the comment section. When it comes to those who love to argue the virtues of growth stocks over dividend investing, we have the pleasure of telling those who try to talk smack about income investments that they can stick it in their pipes and smoke it as our dividends keep rolling in. Whether the market is up or down, our income is strong.

Today, we’re looking at two strong income-generating investments that specialize in pipelines to keep with our pipe theme and offer extremely generous yields for investors.

Let’s dive in.

Pick #1: AM – Yield 8.7%

Antero Midstream Corporation (AM) had laid out a very clear plan for the year. They front-loaded expansion cap-ex, with over 75% of it occurring in the first half, and as a result, they expected free cash flow after cap-ex to fail to cover the dividend in the first half. Then in the second half, they expected to be able to have positive FCF after all cap-ex and after the dividend.

In Q2, AM’s FCF after dividends was negative $2.25 million, and management reiterated that they expect to be FCF positive in Q3 and Q4.

We aren’t worried when management is upfront, provides us with their plan, and then the numbers come in line with their stated plan. In the real world, sometimes you have to spend money to make money. AM failing to cover its dividend is likely one of the main reasons that the stock is so cheap. Asked in the earnings call about the valuation of AM relative to the parent Antero Resources (AR) which has taken off, CEO Paul Rady said:

So whereas AM, I think, is a terrific company, but it’s been in this year or two period where it was relatively flat with dividend — free cash flow after dividends is relatively neutral. It’s about ready to go into a phase of EBITDA growth and declining capital. So that’s not going to be the case in ’23 and ’24. So we do look for AM to appreciate them and to trade better.

In other words, he blames AM’s flat dividend and slim dividend coverage for the depressed price. He is probably right. What is interesting is the outlook that this will not be the case in 2023 and 2024. Rady seems to be implying that there could be a dividend hike in 2023.

We aren’t going to rely on one in 2023. We will be happy with just a larger cushion and are happy if AM applies all excess cash flow towards debt in 2023. In 2024, we absolutely expect a dividend raise. We outlined this in our earnings roundup back in February writing:

Jumping our outlook to 2024, we have even more exciting news on the horizon. AM entered into a fee reduction agreement with AR when it was seemingly on the bounds of bankruptcy. This gave it an infusion of cash flow to service debt. This agreement is saving AR about $350 million between 2020 and 2023. It can be extended every 4 years through 2038, but honestly, there is no valid reason to do so with AR setting record free cash flow numbers and doing large buybacks. AM should see an infusion of extra cash flow once this agreement expires.

AR has been knocking it out of the park, so today, we have an even higher conviction in this statement. From this point forward, we have a company that will be fully self-funding and covering the dividend after all cap-ex. It currently pays a yield around 9% and will see significant earnings growth in 2023/2024, so a dividend hike in 2024 is a highly probable event.

This is what we mean when we say we are long-term investors. We aren’t looking at what AM did today, we are looking at the long-term plan and what AM will bring in the future. The primary reason to watch earnings today is to ensure they are on track and doing what management said they would be doing.

When I order an Amazon (AMZN) delivery, I usually check the delivery details in the morning to see if the package is even in my town. If it isn’t, I know I’m not likely to get the package that day. When I check AM, the trucks are running on schedule and I expect the dividends to be delivered!

Pick #2: MMP – Yield 7.9%

Magellan Midstream Partners, L.P. (MMP) had a great first half producing over $429 million in free cash flow after distributions. They maintained guidance for the year and expect to end the year with DCF coverage at 125%. Their target is 120%, so we can expect a modest distribution hike late this year, probably Q4.

MMP is continuing to prioritize buying back units and intends to continue putting excess FCF into their buyback program, which they are now over $1 billion on their current authorization. Average shares outstanding have declined from 222.9 million last year to 211.7 million. This has the effect of increasing all of the per/share metrics.

MMP is producing substantial amounts for cash flow, and with energy production in the U.S. in high demand, we can expect demand for MMP’s services to continue rising as well. MMP is a blue-chip company in a sector that is seeing a very strong resurgence. We can sit back and collect our growing dividend.

Note: MMP issues a K-1 at tax time

Conclusion

Today, we looked at AM and briefly at MMP, both of which are excellent high-yield investment opportunities. I can take this income and smoke it if I want to! Or, even better, I can use it to reinvest in the market and see my cash flow grow rapidly.

Retirement is a time of life that has expenses similar to before retirement. The biggest difference is that you’re not going to be clocking in for 40 hours a week to draw a paycheck. It’s up to you to find a means to replace that paycheck with income from other sources.

Pipeline operators play an essential and key role in moving the energy we rely on daily. This means they will be a steady income source for decades. A type of income source that retirees looking to have decades of income rolling into their accounts can look to as an excellent source.

For those who are reading today and are not retired yet, reinvest every penny and watch your income grow from a trickle to a roaring river before you know it!