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Analysts urge pipeline companies to avoid excessive distribution growth in 2019

As energy pipeline companies lay out their 2019 financial guidance, analysts are cautioning midstream management teams against emphasizing investor payouts over other uses for excess cash flow like debt reduction and share buyback programs.

Under pressure from institutional investors to bolster liquidity, many pipeline firms in 2018 pivoted toward slower distribution growth and avoided capital markets. Meanwhile, financial results have improved for many due to higher oil and gas volumes on their systems. Several companies that adopted the leaner approach anticipate seeing excess cash flows in the coming calendar year, and analysts say shareholders are not looking for a bigger payday at balance sheets' expense.

"Investors don't want or need payout growth. They need leverage reduction," Robert W. Baird & Co. Inc. midstream analyst Ethan Bellamy said in an email.

If a midstream company is already able to self fund its capital needs, energy investment bank Tudor Pickering Holt & Co.'s Colton Bean said it should repurchase shares instead of increasing distributions.

"You're reducing your share count, you're increasing your cash flow per share. … You see a pretty immediate impact to valuation," the midstream analyst said in an interview. "For the dividend ramp I think the fear is that, if you don't see any sort of entries in yield-oriented investors, it may fall on deaf ears and not actually translate into much of a valuation improvement."

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Both Kinder Morgan Inc. and Enbridge Inc. plan to grow annual dividends by double-digit percentages in 2019. Plains All American Pipeline LP's aim to restart distribution growth as early as the first quarter of next year after implementing a 45% distribution cut in 2017 is particularly "contentious," Bean added.

"They've been getting some feedback from investors that we'd rather you actually put that money towards the share count," he said.

Enbridge Executive Vice President and CFO John Whelen, meanwhile, acknowledged during the pipeline giant's recent analyst and investor conference that the industry is not rewarding dividend growth. "I think for buybacks, there may be a pocket of the investor community looking for that," he said Dec. 11.

The master limited partnership model that dominated the pipeline sector for decades prioritized satisfying shareholders' appetite for regular distribution growth, until a commodities price downturn that began in 2014 required midstream companies to cut those payments in order to balance the books. Income-oriented investors exited the pipeline space, and a new crop of institutional shareholders urged management teams to ditch the MLP structure for a more sustainable solution to low stock prices.

In 2018, many of the remaining MLPs shed their cash-leaking structure through either merging with general partners or rolling up into parent corporations. Negative sentiment toward the broader energy space has still deterred new investors from entering the sector. As of market close on Dec. 14, the bellwether Alerian MLP Index had lost 11.6% on a price-return basis since the beginning of the year.

Kenny Feng, President and CEO of midstream data and index provider Alerian, urged midstream finance professions in October to avoid re-focusing on targeting retail investors.

"You saw significant abuses of [distribution growth] in the past where someone would put out a press release and say that they grew their distribution by one-tenth of a cent just to keep that streak going, and that needs to stop," he said.