Coverage ratios, and why the distribution is the only promise that counts

It traded at 31.39 this morning, -0.14% on the session. Income investing has one job, which is to keep receiving the income, and most of the ways it goes wrong are visible in advance.

Why the yield is the least useful number

A high yield is either compensation for risk or a market forecast that the distribution is coming down. It never tells you which on its own, and buying on yield alone reliably selects for the second.

What tells you is coverage. How much distributable cash the business generates against what it pays out. Comfortably above one and the payment is funded by operations. At or below and it is being funded by the balance sheet, which works until it does not.

What I require

• Coverage with real headroom, not a figure that only works in a good year
• Leverage inside a range the business has actually operated at through a downcycle
• Contracted, fee-based revenue as the bulk of it, rather than anything with commodity price exposure dressed up as infrastructure
• A maturity schedule with no cliff arriving into a market that might be closed

The last one gets ignored constantly. A perfectly sound business can be forced into a bad decision by a refinancing that lands at the wrong moment.

Where I stand

Long. Coverage is comfortable, the revenue is genuinely contracted rather than nominally so, and the leverage is inside what this business has carried before without distress.

A distribution is a promise. Coverage is whether the promise is funded. Yield is only what the market thinks of the answer.

The risk

Growth capital spending. The way a well-covered payer becomes a poorly covered one is rarely a demand collapse. It is a large project, announced with enthusiasm, funded partly out of the cash that was covering the distribution.

I would turn neutral on a material step up in growth capex that is not matched by contracted revenue attached to it.