Description

DCP is one of the most hated stocks in one of the most hated sectors, but I believe DCP preferred stock has been unduly hit and offers a compelling risk/reward. DCP preferred trades at 50% of face value and have a current yield of 16%. The preferreds “create” DCP at a 5.6x trailing EBITDA multiple, so I believe the risk of permanent impairment is low even with a substantial drop in EBITDA. Finally, DCP is controlled and majority owned by two financially solid companies (Enbridge and Philips 66) and this strong equity sponsorship adds to the margin of safety.

The MLP sector has suffered incredibly due to oil price exposure and leveraged balance sheets. On top of this, there have been many forced sellers (levered funds and retail investors getting margin calls) and a lack of buyers to step in (many institutions can’t own because MLPs issue K-1s). In this hated sector, DCP screens as one of the worst stocks given its gathering processing exposure (50% of earnings), high leverage (4.9x trailing debt/EBITDA) and small capitalization ($1.3bn with only $575m float). DCP common is down –75% YTD vs. –53% for the AMZ index. In the midst of this carnage, DCP preferred stock is down –50% in the last few weeks and has become quite attractive.

DCP has $1.150bn of bank debt, $4.225bn sr notes and $550m junior sub notes. 2019 EBITDA was $1.2bn so total debt/EBITDA is 4.9x on a trailing basis. Although debt levels are high, liquidity looks fine over next few years with $585m undrawn revolver capacity (assuming they put their $600m March 2020 maturity on their revolver). The undrawn revolver is sufficient to cover DCP’s next debt maturity of $500m in Sept 2021. The next maturity after that is $350m in April 2022.

DCP preferred stock totals $771m in face value and sits just beneath the debt and ahead of $1.3bn equity market cap. The preferred stock is “creating” DCP at 5.6x trailing EBITDA (5.2x if you use the market price of preferred). There are 3 series of pari passu preferred stock, but I will quote the series B here for convenience. The Series B preferred trade at $12.50/share which is 50% of their $25/share face value. The cumulative coupon is 7.875% which adjusts to L+4.9% in June 2023. The current yield is 16% and 13% assuming the adjusted coupon.

EBITDA will drop from 2019 levels due to lower oil prices, but I’ll admit I don’t know how much. For modeling purposes, I am guesstimating a 20% drop. Note that DCP has growth capex projects which will complete later this year, so on an organic basis, this is a ~25% drop. Using ~$950m EBITDA the face value of preferred creates DCP at 7.0x EBITDA (6.6x using market price of preferred). Starting with $950m of EBITDA and subtracting out $320m interest, $70m sustaining capex, $150m in growth capex gets to $410m of cash flow before preferred dividends of $58m, which means preferred dividends are 7x covered. Growth capex is elevated in 2020 as they complete projects in progress, but should drop to $50m in 2021, improving preferred dividend coverage to 9x.

Preferred dividends must be paid before any common distributions are allowed. DCP recently cut its common distributions by 50% which is $325m/year. After paying common distributions, DCP is not generating any FCF on $950m of EBITDA and $150m growth capex. I personally think they should have cut the common dividend even more than 50% to accelerate debt paydown, but this is a lever DCP could pull in the future that would benefit the preferred holders. Given that common is yielding 24% on reduced distribution, it appears the market may be pricing in further distributions cuts.

DCP’s general partner is jointly owned by Enbridge (ENB is Baa2/BBB+ rated with $58bn mkt cap) and Phillips 66 (PSX is A3/BBB+ rated with $27bn market cap). I believe that this strong sponsorship adds to the margin of safety on the preferred stock. These companies each own 28% of the common, leaving 43% as the public float. Further, ~14% of DCP’s 2019 revenues were transactions with PSX. I believe if DCP runs into further trouble, the sponsors could inject more equity into DCP. Each of ENB and PSX’s DCP common stakes is worth $376m at current prices. Given the small value of their DCP holdings relative to the size of ENB and PSX, it would be a rounding error for the sponsors to inject equity to preserve their reputations in the marketplace.

Catalyst

Stabilization in oil prices will help sentiment in the sector

Further reduction in common dividend would be supportive of preferred