Williams Companies Inc (WMB) – The Dividend Cut Is a GOOD Thing

For investors in natural gas midstream giant Williams Companies Inc (NYSE:WMB), this hasn’t been a great couple of quarters. Its proposed mega-merger with Energy Transfer Partners LP (NYSE:ETP) was supposed to be a slam-dunk and create one of the largest energy logistics firms in North America. Well, after months of in fighting and lawsuits, that deal isn’t happening.

Williams Companies Inc (WMB) - The Dividend Cut Is a GOOD ThingSo how does WMB reward its shareholders? By cutting its dividend nearly 70%.

But don’t take that for sarcasm. I actually do mean reward. For Williams, the dividend cut is less about cash flow degeneration and more about copying another midstream masters to better itself over the long-term — a long-term that actually will include plenty of dividend increases.

For investors, the dividend cut is really a good thing.

WMB Cuts With a Purpose

The new mantra for many midstream and master limited partnerships these days seems to be “live within your means.” As oil prices dropped, access to critical cash became hard to come by. And the drop in energy prices also had its way with share prices. That meant tapping the equity markets was out of the question.

For many MLPs and pipeline firms that meant cutting their lucrative dividends to save cash. It’s what superstar Kinder Morgan Inc (NYSE:KMI) did and more recently, Plains All American Pipeline, L.P. (NYSE:PAA) was forced to do.

For Williams, it was a similar story.

Without ETE, WMB’s cash flows and distribution coverage ratios were a bit too close for comfort. Especially, when you considered that it needed a lot of capital to fuel its growth proposals. So, with the deal D.O.A., Williams decided to slash its payout to just 20 cents a share. That’s down from 64 cents per quarter.

That move will save it roughly $1.3 billion a year. But what it’s doing with that cash is the key to WMB’s future.

Where It Gets Interesting For WMB

Williams will take that $1.3 billion and reinvest it into its MLP subsidiary Williams Partners LP (NYSE:WPZ). WPZ actually owns the vast bulk of WMB’s pipeline, processing and storage assets. Remember, general partners (WMB) will “drop-down” their assets in MLPs (WPZ) in order to save on taxes. Williams has done that dance to a ‘T.’

With that investment comes ownership of additional units of WPZ. However, rather than take payouts from Williams Partners right away, WMB is going let those distributions “reinvest” into other units of WPZ. The idea is that the MLP will be able to pay down its hefty debt load and maintain its much needed investment-grade credit rating.

WPZ will be able to fund projects organically from its own cash flow generation once the debt is lower. That’s good, because WMB and WPZ have many big-time projects moving natural gas in the nation’s hottest shale regions. Those projects should provide Williams with a lot of distributable cash flows over the long haul, which is why the reinvestment of WPZ units is key.

Just like regular retail investors, WMB is engaging in dividend growth investing. Each quarter, it’ll buy more WPZ units, which will throw off more dividends, which will buy more units. That’s huge for WMB’s future cash flows and own dividend potential. That doesn’t even take into account the potential for WPZ to raise its dividend even further after its debt is lower and new projects kick in. Already, WPZ’s cash flows have been steadily increasing.

But the reinvestment of dividends isn’t the only way that WMB wins. As the general partner, it is entitled to what’s called incentive distribution rights. Basically, IDRs are bonus payments that GP’s get for growing an MLP. As WPZ increases its dividends, WMB will get a larger first cut of those payments. That’s in addition to the now increased dividends it receives on its plethora of owned units.

By forgoing a little current cash now, WMB is going to have a ton of it later on.

And it might just have all the cash flows later on. Before it was tangling with ETE, WMB was exploring the idea of rolling-up its MLP back into itself. Similar to what Kinder Morgan did. Some analysts have postulated that with Energy Transfer out of the picture, Williams could actually do that transaction.

Buy WMB Today for Bigger Dividends Tomorrow

Under the terms of its “deal” with WPZ, Williams is willing to forgo receiving dividends from its MLP until the end of next year. At that point, it’ll reevaluate how much of the dividends it wants to receive. Analysts anticipate that WMB will begin raising it dividend by 2018 on the back of additional cash flows from the extra dividends it’ll receive from WPZ. BMO Capital Markets actually thinks that Williams will be able to increase its dividend to $2 per share annualized.

That’s a 150% jump in just one year.

For investors, that means that WMB stock right now is a bet on some serious future dividend growth. And based on its moves to strengthen its MLP, reduce expenses and eliminate debt, that dividend growth is almost certain to happen.

And that will make investors who buy shares today very happy over the long haul. For those stockholders who already own WMB, the cut is painful today. But you’ll end up with a much stronger midstream firm overall.

The Bottom Line: The dividend cut and reinvestment plan at Williams could be its most exciting move ever. In the long run, it makes WMB stock a big buy.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2016/08/wmb-stock-williams-companies-dividend-cut/.

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