A High-Yield Stock to Think About
If I tell you there’s a stock providing an annual distribution yield of 10%, your first reaction might be, “Is the distribution safe?”
Indeed, dividend safety, or rather the lack of it, has been the No. 1 concern for yield-seeking investors. While we all want to boost the returns of our income portfolio, in today’s ultra-low interest rate environment, a dividend yield in the double-digit range simply seems too good to be true.
Therefore, if you actually own shares of a double-digit yielder, you might be worried about when the next dividend cut is going to come.
Not if you own KNOT Offshore Partners LP (NYSE:KNOP), though.
On January 15, KNOP’s board of directors declared a quarterly cash distribution of $0.52 per unit. The distribution is payable on February 13 to unitholders of record as of January 31. (Source: “KNOT Offshore Partners LP Announces Fourth Quarter 2019 Cash Distribution,” KNOT Offshore Partners LP, January 15, 2020.)
At the current share price, that quarterly distribution rate translates to an annual yield of 10% for KNOP stock.
Note that we’re not talking about some stock whose yield went up purely due to terrible share-price performance. As a matter of fact, the price of KNOT Offshore Partners stock actually rose about 10% over the past 12 months.
And because the partnership’s cash distributions remained steady over this period, its yield actually went down. That is, the stock was offering a yield of well above 10% a year ago.
Yet investors of KNOP stock didn’t really have to worry much about distribution safety.
You see, as a master limited partnership (MLP), KNOT Offshore Partners reports something called distributable cash flow. To see whether KNOP’s payout is safe in a given reporting period, all you need to do is compare its distributable cash flow to its actual cash distributions.
KNOT Offshore Partners last reported earnings in November 2019. The report showed that, in the third quarter of last year, the partnership generated $28.0 million of distributable cash flow. (Source: “KNOT Offshore Partners LP Earnings Release—Interim Results for the Period Ended September 30, 2019,” KNOT Offshore Partners LP, November 20, 2019.)
Considering that KNOP declared $18.0 million of cash distributions to unitholders during the quarter, its distribution coverage ratio was almost 1.6 times.
In other words, the MLP generated almost 60% more cash than the amount needed to fulfill its distribution obligation for the quarter. When it comes to double-digit yielders, that is considered a very wide margin of safety.
KNOT Offshore Partners LP Maintains a Safe Payout
Now, you are probably wondering how this high-yield stock managed to afford this level of payout.
Well, KNOT Offshore Partners is in the shuttle tanker business. The partnership currently has a fleet of 16 vessels. These vessels transport oil from offshore installations to onshore facilities. (Source: “Our Fleet,” KNOT Offshore Partners LP, last accessed January 24, 2020.)
The energy industry can be quite volatile due to the wild swings of commodity prices. The good news is, KNOP’s business is backed by long-term charters.
To give you an idea, at the end of September 2019, the partnership’s fleet had an average remaining fixed contract duration of 3.1 years and another 4.3 years on average in charterers’ option. (Source: “Third Quarter 2019 Results,” KNOT Offshore Partners LP, November 21, 2019.)
I would like to point out that KNOT Offshore Partners was founded in 2013 and went public in the same year. In hindsight, that was probably not the best time to enter the business because, in the summer of 2014, oil prices crashed big-time and are yet to make a full recovery.
But take a guess of what happened to KNOT Offshore Partners stock’s distributions?
Nope, the partnership did not cut its payout.
When KNOP stock went public, it had a quarterly distribution rate of $0.375 per unit. Its first distribution of $0.317 per unit paid in August 2013, however, was a prorated payment corresponding to the quarterly rate. (Source: “Distribution Policy & History,” KNOT Offshore Partners LP, last accessed January 24, 2020.)
Since then, management has raised the partnership’s quarterly distribution rate on four different occasions, by a total of 38.7%.
In fact, even during the massive oil price downturn—when many energy companies reduced their dividends—KNOT Offshore Partners was still raising its payout to investors.
I’m not saying this MLP is perfect, but for those who want to earn a double-digit yield in today’s market, KNOT Offshore Partners stock is one of the few names worth checking out.