I've written several articles lately drilling down into Eagle Rock Energy Partners . It's a very interesting company because of its balance of both upstream oil and gas operations and its growing midstream business. Together, these two operations produce a very high distribution for investors. The only question that remains is how safe is that more than 13% yield.
Distribution coverage ratio
The first place to look when considering the safety of an MLP's distribution is the distribution coverage ratio. In this case, the company is well under the critical 1.0 times marker. A terrible first quarter followed by an equally lousy second quarter didn't help, which is why the company's coverage ratio is currently a worrisome 0.65 times.
This coverage ratio is not sustainable, but Eagle Rock sees a path forward to improve it. First, it sees increased oil and gas production being led by its position in the SCOOP. Further, the company recently completed its Wheeler plant which will start producing cash flow. Finally, it's beginning to see the benefits of its acquisition of BP's midstream assets. It's those BP assets that are a key to its long-term growth. As BP drills wells on the dedicated acreage, Eagle Rock will earn fee-based income, which will help it to bridge the deficit in its coverage ratio.
The other area to watch is the company's liquidity picture. The company is pushing up very close to its 4.75 times leverage ratio as its total debt to adjusted EBITDA ratio stood at about 4.5 times as of last quarter. What that means is that despite having $215 million available on its credit facility, it can't spend that much because its leverage ratio is too high. That's causing the company to cut about $100 million in capital spending this year, which will reduce future cash flows.
What's the future of the distribution?
The distribution doesn't look like a very safe bet to me at the moment. First, the company's midstream business is subject to commodity price fluctuations -- just a third of its cash flows are protected by fee-based agreements. When compared to industry giant Enterprise Products Partners , which, for example, has fee-based earning in excess of 80%, it is clear that Eagle Rock's midstream earnings are not exactly rock-solid. Having rock-solid earnings backed by fee-based contracts is one reason why Enterprise has been in the position to raise its distribution for 36 straight quarters, whereas Eagle Rock's payout is potentially in danger of being cut.
What could save Eagle Rock's payout is its ability to monetize its acreage in the SCOOP. The company has been approached by a variety of interested parties to either buy its assets in that emerging oil play or swap assets that are better suited for its MLP structure. If the company can extract a premium value for its assets, it could put itself in the position to reduce its debt burden while also strengthening its distributable cash flow.
Final Foolish thoughts
It's the company's intriguing position in the SCOOP that could be enough to entice some investors to take a flyer on the company. However, while Eagle Rock could drill wells with high rates of return in the play to grow its way out of the current troubles, it might not be able to do so fast enough considering its liquidity constraints. Investors who are looking for a rock-solid distribution might want to look elsewhere because Eagle Rock's units could sink if the company is forced to cut its payout.
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The article Will This Energy Company Sink or Soar? originally appeared on Fool.com.
Fool contributor Matt DiLallo owns shares of Enterprise Products Partners L.P. The Motley Fool recommends Enterprise Products Partners L.P. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.