This High-Yield Dividend Stock Could Richly Reward Investors

FAN Editor

Targa Resources (NYSE: TRGP) has proved its doubters wrong. The midstream company has been successful where most rivals failed. It was able to find ways to continue paying its high-yielding dividend even as it has invested billions of dollars in expanding its infrastructure footprint.

Because of that, the company is about to reach a key inflection point. Earnings are set to accelerate, which will give it much more cushion to continue paying its 9.3%-yielding dividend. Those factors could give it the fuel to generate significant total returns over the next few years.

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Walking a tight rope by staying one step ahead

Targa Resources hauled in $942.4 million in cash flow last year. While that was about 11% higher than 2017’s total, it was barely enough to cover the dividend. That put the company in a tight spot because it’s in the process of investing several billion dollars into building additional midstream infrastructure to support the growth of its customers.

Instead of slashing its high-yielding payout so that it could retain more cash to fund growth, the company has gotten incredibly creative. Early last year, for example, Targa formed development joint ventures with private equity fund Stonepeak Infrastructure Partners. This partnership provided Targa with $960 million to help finance three large-scale projects.

Meanwhile, this past February, the company sold a 45% interest in its gathering and processing assets in the Bakken Shale to another private equity fund for $1.6 billion. The company also formed a joint venture with another midstream company to build a new natural gas processing plant and sold some non-core assets.

These transactions brought in a substantial portion of the cash Targa needed to fund growth. That helped the company avoid significantly diluting its existing investors by selling more stock. Further, it allowed the company to maintain a solid balance sheet, even as it kept paying its high-yielding dividend.

Nearing an inflection point

Targa expects to bring more than $2.5 billion of expansion projects online by the second half of this year. These include several needle movers such as the Grand Prix natural gas liquids (NGLs) pipeline that should start up in the third quarter.

These expansions set the company up to generate between $1.3 billion and $1.4 billion of EBITDA this year. That’s about even with last year’s level, due to asset sales. However, EBITDA will start ramping up significantly over the back half of the year due to the timing of its expansions.

EBITDA should continue increasing at an accelerated pace over the next two years. Targa sees it reaching nearly $2 billion by 2020 and approaching $2.5 billion in 2021. Meanwhile, the company has several opportunities to continue expanding its EBITDA beyond 2021, including buying out its development joint-venture partners and completing further expansions of Grand Prix.

As earnings head higher, it will improve the company’s dividend payout ratio from the currently unsustainable level of nearly 100%. With earnings on track to almost double over the next several years, Targa could eventually be in the position to increase its already generous dividend.

Two ways to win

Targa Resources has managed to maintain its high-yielding dividend even as it has invested heavily to expand its portfolio. Because of that, its investors could cash in as those expansions begin entering service.

Not only will they be able to continue collecting a monster payout, but they should benefit from the company’s stock price, which should rise with earnings. Those dual fuels could help Targa produce significant total returns over the next few years.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends Targa Resources. The Motley Fool has a disclosure policy.

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