It’s not often that I look at a stock with a 12% yield and think, “That SafetyNet Prorating seems kind of low.”

When I dug into the numbers for Energy Transfer Partners (NYSE: ETP), I realized the rating is right, but the company could be on the verge of an upgrade if it has a decent 2016.

The natural gas pipeline master limited partnership pays an annual distribution (MLPs pay distributions, not dividends) of $4.22 per share. That gives it a yield of 11.9%.

The company has an impressive track record of raising the distribution, boosting it 33 times since 1999 with no cuts. There have been several periods when the company lifted the payout every quarter, but others when it has stalled, as it did from 2008 to 2013. Its most recent raise was in November. It should be announcing the May distribution any day now.

The other attractive aspect is that Energy Transfer Partners grew its cash available for distribution (a measure of cash flow) by nearly 5% in 2015.

But there are a few issues to be concerned about.

Cash flow is expected to drop sharply in 2016 to $2.47 billion from $3.4 billion, in part due to low revenue from customer Chesapeake Energy (NYSE: CHK). Cash flow is expected to fall even further in 2017.

The reason that’s worrisome is that in 2015, for the first time in several years, the company did not generate enough cash flow to pay the distribution.

Last year, Energy Transfer Partners generated $3.445 billion in distributable cash flow while it paid out $3.468 billion for a coverage ratio of 0.99. That means for every dollar it paid out in distributions, it generated $0.99 in cash flow.

You always want to see that coverage ratio be above 1, meaning the company’s cash flow is higher than what it’s paying out to unit holders (MLPs have units, not shares).
In 2014, cash flow was a bit lower, but the distributions were much less. The coverage ratio was 1.59 – meaning that for every dollar Energy Transfer paid out in distributions, it generated $1.59 in cash flow.

If cash flow slips 20% next year, as it is expected to, the coverage ratio could be significantly below 1. At that point, the company would either have to cut the distribution, fund it from cash on hand or raise debt.

At the end of 2015, Energy Transfer Partners did have $4.7 billion in current assets, though it didn’t say specifically what was cash. But theoretically, it should be able to turn those assets into cash fairly quickly if it needs to.

The company has more debt than equity – $28.5 billion in debt compared to $27 billion in equity – which is a problem. If it needs to go to the debt markets to fund the distribution, it may find it difficult, particularly when revenue and cash flow are declining.

Management has stated it wants to get its coverage ratio back to 1.05. That can be achieved only two ways: cut the distribution or increase cash flow. It doesn’t appear cash flow will increase in 2016.

That being said, if the company can surprise Wall Street with more cash flow than forecast, the stock could get an upgrade from SafetyNet Pro early next year. Though I suspect investors may have to wait until 2018 before they can feel confident their distribution is safe.

For now, investors shouldn’t rely on the distribution too much. Although Energy Transfer Partners has a great track record when it comes to paying unit holders, that track record will be tested in 2016.

Dividend Safety Rating: D