Cypress Energy Partners: Distribution Compromised

Demand for crude oil and natural gas expected to remain strong in the coming years.

The company seems to have a healthy debt level.

CELP\'s distribution may be unsustainable as indicated by the DCR.

I am unsure if this is the right time to invest in Cypress Energy Partners LP (CELP). On the positive side, the company seems to have a stable operational performance. Further, it appears that it has a healthy debt level. On the other hand, I am unsure that the distribution is sustainable. The best course of action is to avoid a long position in CELP.

The demand for natural gas and crude oil seems strong. On the crude oil side, the EIA is expecting the world crude oil consumption to increase by an average of 1.1 million barrels per day in 2019. For 2020, the agency is forecasting an increase by an average of 1.4 million barrels per day. Although the global economy is slowing down, it is still growing. Also, if the global economy slows down, several central banks can cut rates to stimulate their economies. The Bank of England, the Fed, and the Bank of Canada are in the best position to lower their rates. On the other hand, the ECB and the Bank of Japan may be limited.

On the natural gas side, the outlook also looks strong. The U.S. consumed almost 30 trillion cubic feet of natural gas in 2018, up 10% from the previous year. Also, it is essential to mention that this has been the most significant jump in natural gas consumption YOY since 2000. Moreover, I believe that the higher natural gas consumption trend will continue in the coming years. One of the drivers will be the continuing shift in electricity production from coal to natural gas.

Source: Image created by the author. Data collected from the EIA.

Source: Image created by the author. Data collected from the EIA.

My go-to indicator to measure the operational performance of a company is the DuPont ROE analysis because it provides a complete picture of the entity's state. The inputs and results are shown in the following charts.

Source: Image created by the author. Data collected from the SEC EDGAR website.

Source: Image created by the author. Data collected from the SEC EDGAR website.

The first item worth discussing from the analysis is the varying tax burden ratio. The metric is important to me, especially on MLPs, because it indicates whether the company is truly acting as an MLP. Since MLPs are considered pass-through entities, I expect all MLPs to have a tax burden ratio close to 1.0. In CELP's case, the tax burden has been 0.96 on average. This indicates that the company is taking advantage of the MLP status.

Another item worth discussing is the operating income margin. Although it is positive, the margin compressed in 1Q 2019 due to seasonality. Therefore, for 2Q 2019, I am looking forward to seeing an operating margin close to 5.0%.

On a positive note, asset turnover has increased. Going forward, I want to see the asset turnover ratio above 0.50, which is the company's trailing six-quarter average. This is not an industry benchmark by any means.

Lastly, I am happy to see the equity multiplier drop from the 2017 levels after a private placement. However, it has been ticking higher since 2Q 2018. Therefore, in the next earnings report, it is imperative to see a stabilizing equity multiplier around 2.20.

Because of seasonality, the ROE ranges between 2.14% and 9.58%. In 2Q 2019, I am looking forward to seeing an ROE ratio close to 5.0%, which is slightly higher than the 2Q 2018 ROE.

I think that the answer is yes. I am not concerned that CELP can repay its debt. The interest cover ratio (ICR), which measures the ability to pay the interest expense, has been above 2.0 for the past four quarters. Although I prefer ICRs above 3.0, I am not overly concerned about CELP's ability to pay its creditors yet. Going forward, I want to see the ICR above 2.00. Indeed, an ICR below 2.00 will pop a warning flag in my mind, and an ICR below 1.00 will raise the bankruptcy flag.

Source: Image created by the author. Data collected from the SEC EDGAR website.

On the financial leverage side, I think that the company's debt level is healthy and sustainable. My preferred metric is the D/E ratio, which has been close to 1.00 for the past four quarters. In 2Q 2018, CELP lowered the D/E ratio to 1.00 from 4.36 in 1Q 2018 after the company issued and sold 5,769,231 million Series A preferred units in a private placement for gross proceeds of $43.5 million.

Source: Image created by the author. Data collected from the SEC EDGAR website.

From the debt perspective, it seems that CELP has a sustainable debt for now. However, I will be looking forward to seeing stable interest coverage and D/E ratios in 2Q 2019.

My preferred indicators are the distribution coverage ratio (DCR) from the net income and the cash flow from operations (CFO). In brief, I am worried that the distribution may not be sustainable. Over the last four quarters, the company has generated $12.3 million in net income, and it has paid $13.5 million in distributions. The DCR is below 1.0, and I am concerned.

Moreover, from the CFO perspective, the picture looks even worse. Over the last twelve months, the company posted cash outflow from operations for $4.8 million, and it paid $13.5 million in distributions. This is a major flag for me as an equity holder. The main driver for the cash outflow was an increase in accounts receivable to $71 million in 1Q 2019 from $49 million in 4Q 2019. Historically, the accounts receivable amount has been between $40 million and $50 million. Therefore, I will also pay close attention to the accounts receivable in the next quarter, hoping that it returns to the $40-50 million range.

Source: Image created by the author. Data collected from the SEC EDGAR website.

Source: Image created by the author. Data collected from the SEC EDGAR website.

I am on the fence on CELP. On the one hand, it seems that the company has a reliable operational performance and that it can pay its creditors. On the other hand, I am concerned about its distribution sustainability. Therefore, my course of action is to not invest in CELP now.

I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure:

The opinions expressed herein are the author’s sole views, and they do not constitute investment advice in any form. Past performance may not be indicative of future performance. Always do your due diligence, and determine if the investments mentioned here suit your risk tolerance and objectives, your return objectives, and your personal constrains.