Earlier this year, Tallgrass Energy GP (NYSE: TEGP) agreed to acquire its master limited partnership, Tallgrass Energy Partners (NYSE: TEP) in an all-stock deal. This transaction is one of many similar ones in the sector over the past few years as energy infrastructure companies have had to grapple with the fallout of the oil market downturn. Like the deals before it, and those announced afterward, the transaction will create one stronger entity that’s well positioned to grow in the coming years while still offering income-seeking investors a generous income stream. That income with upside makes Tallgrass a stock that investors will want to keep on their radar, especially considering the strength of its financial profile.
Fortifying the foundation
Tallgrass Energy currently expects to close its acquisition of Tallgrass Energy Partners by the end of the second quarter. Once that deal closes, the combined company should cover Tallgrass’ 9%-yielding dividend with cash flow by more than 1.2 times. Furthermore, that company will generate very predictable cash flow going forward since 97% will come from long-term, fee-based contracts. Those are both solid numbers for a pipeline company. For comparison’s sake, Tallgrass’ coverage ratio will roughly match that of pipeline giant ONEOK (NYSE: OKE), which currently gets about 90% of its cash flow from predictable sources like fee-based contracts.
Aside from offering investors a well-covered, high-yielding dividend, the newly combined Tallgrass Energy will also boast a solid balance sheet. The company’s consolidated leverage ratio should be around four times, which puts it solidly in investment-grade territory and is about the same as ONEOK’s leverage ratio.
A look at what’s up ahead for Tallgrass
That strong balance sheet and conservative dividend payout level will help provide Tallgrass with some of the funding it needs to capture the growth opportunities up ahead. The company has already secured $340 million of organic growth projects and third-party acquisitions since the start of the year, to go along with the $650 million of growth-focused investments announced last year. As these projects come on line, they’ll not only grow Tallgrass’ cash flow but diversify its asset base.
In addition, Tallgrass has more than $1 billion of expansion projects in development that could enhance its growth prospects in the coming years. One of the areas where the company sees compelling opportunities is in the Powder River Basin, where it made several acquisitions last year to become a one-stop midstream shop for producers in the region. It is currently evaluating several opportunities to expand the integrated system it built over the past year.
The expansion projects Tallgrass has underway, as well as those in development, help position the company to grow cash flow at a brisk pace in the coming years. That rising cash flow stream gives Tallgrass several options to create value for investors, including investing in new growth projects, paying down debt, buying back stock, or increasing its already-lucrative dividend at a healthy pace.
An interesting income stock
Tallgrass Energy currently offers investors a well-supported dividend that yields an eye-popping 9%. That makes it an attractive option for income seekers, especially compared to ONEOK, which only yields 4.6% despite paying out roughly the same percentage of its cash flow. While ONEOK does offer better dividend growth visibility since it expects to increase its payout at a 9% to 11% annual rate through 2021, Tallgrass could also produce healthy dividend growth in the coming years if that’s where it decides to allocate its growing cash flow stream. That upside potential makes it an income stock worth watching.
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