With an 8% return, is Crestwood Equity Partners undervalued right now?

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IInterest in the oil and gas industry quickly caught the attention of Wall Street. Even before the recent geopolitical turmoil in Europe, energy prices were on the rise, with some long-term factors suggesting a period of high energy prices for some time.

One place investors immediately turn to at times like this is high yield dividend stockss. While a high return can sometimes mean a company is in trouble, it can also be a sign that the stock is undervalued. One such high yielding stock in the oil and gas industry is Crestwood Equity Partners (NYSE: CEQP)with a payout yield of 8.2% to date.

Is Crestwood a safe stock that trades at a discount, or a high yielding stock that risks seeing its payout reduced? Let’s look at the company to find out.

Image source: Getty Images.

Not all pipeline companies are the same

the oil and gas industry is broken down into approximately four categories: exploration and production, pipelines and midstream, refining and marketing, and equipment and services. One heuristic that investors can use to gauge risk in these segments is that pipelines and the midstream tend to be among the least volatile investments in the industry. This is because the midstream tends to have the least exposure to commodity prices and tends to work on contracts that earn a fee for the use of a pipe, storage tank, or facility. treatment.

Digging a little deeper, however, there is another heuristic for valuing midstream companies: the closer these assets are to the actual well, the riskier they become.

Think of it this way. A pipeline or storage facility that carries oil and gas from thousands of wells across the country doesn’t care if a single well fails. If a company owns a pipe that comes from a well, any disturbance to that well will be significant. Moreover, when this well no longer produces, the economic value of this pipe is also exhausted. This is a more pressing issue with shale wells, as production rates are high at first but decline quickly.

This is where Crestwood operates. Its assets are primarily gathering and processing infrastructure designed to extract product from individual wells and aggregate them to a central location. It does this for oil, gas and water produced from hydraulic fracturing. If, for example, a shale basin where Crestwood operates is too expensive to drill at a certain price level, then its gathering and processing assets are unlikely to be utilized to their full capacity. That’s probably not an issue at current oil prices, but it’s definitely something to keep in mind when investing in this part of the industry.

Fix flaws with good management

Fortunately for Crestwood investors, management has managed to mitigate much of the risk associated with this particular part of the midstream business. There are three things management does, in particular, that stand out here:

  • The contracts he uses to ensure more stable income.
  • Better credit quality customers.
  • A conservative approach to cash flow management and leverage.

For an intermediary company, it is essential to guarantee stable and predictable revenues, contracts and their structure. In the case of Crestwood, the company primarily engages growers in what are called take-or-pay contracts with dedicated acreage. Take or pay means that a producer must pay for the use of a pipeline or facility, whether it is physically used or not. Dedicated acreage means that if a producer drills a new well within the scope of this contract, then that producer must use Crestwood’s assets. When last presented to investors, 83% of Crestwood’s contracts were take-or-pay and it had 1.7 million acres under dedicated acreage contracts.

Management also reduces its risk by working primarily with companies of higher credit quality. The last thing you need after spending tens of millions in assets on a client is for that client to be unable to pay the bills. Crestwood’s customers are a combination of some of the largest oil and gas producers, other midstream companies and refiners, most of whom have investment grade credit ratings.

Finally, just in case the oil and gas market does not work in Crestwood’s favor, management is taking a conservative approach to how much does it bring to investors and control its level of indebtedness. As of last quarter, its distribution coverage ratio – a measure of the amount of cash available to pay a distribution divided by the amount actually paid – for 2021 was 2.4, and management expects its payout for 2022 to be within the range from 2.0 to 2.2. For reference, a ratio above 1.5 is considered a pretty healthy payout cushion in this industry. Management also aims to maintain its leverage – measured as over-adjusted debt EBITDA — between 3.25 and 3.75.

Is it undervalued?

“Undervalued” and “overvalued” in high-dividend companies can be tricky concepts. If you are looking for a stock that will see significant price appreciation in a relatively short period of time, then Crestwood Equity Partners is probably not the stock you are looking for. Crestwood is going to be a slow-growing, big-money-making company for shareholders. If you’re looking for a company that will pay you a solid dividend that can be reinvested or used to supplement your income, there aren’t many companies that can beat Crestwood in terms of current yield, relative security of payment, and modest upside. prices.

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Tyler Crowe has no position in the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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