NGL.PRC: A Contrarian Opportunity in Energy Midstream Preferreds

The energy sector has long been a battleground for income investors, balancing high yields against volatility. Among the contenders, NGL Energy Partners LP's 9.625% Class C Preferred Units (NGL.PRC) stand out as a compelling contrarian play. With a 13.26% current yield, a 4.08% discount to its $25 liquidation preference, and a post-call date floating rate structure, this security offers an intriguing mix of income potential and relative safety in a volatile market. Let's dissect its merits and risks.

The Yield Advantage: 13.26% vs. 9.63%—Why the Gap?

The Class C preferred units were originally priced to yield 9.625% on their $25 liquidation preference. Today, trading at $23.98, they offer a 13.26% current yield—a significant premium to their issuance terms. This spread reflects market skepticism about NGL's energy midstream business, which faces headwinds from commodity price swings and sector-wide leverage concerns. Yet, the discount also creates a yield cushion: even if the stock price recovers to $25, the yield would drop to 10.3%, still attractive relative to broader preferred markets.

Floating Rate Stability Post-April 2024

Starting April 15, 2024, NGL.PRC's dividend transitioned to a floating rate formula: Three-Month LIBOR + 738.4 basis points. While LIBOR's phase-out introduces some uncertainty (more on this later), the structure ensures distribution stability post-call date. The fixed spread of 738.4 bps guarantees a floor even if short-term rates fall, while the link to LIBOR ties payouts to macroeconomic conditions. For income seekers, this hybrid approach mitigates the risk of sudden rate hikes eroding yields.

Cumulative Dividends: A Safety Net in Volatile Times

NGL.PRC's cumulative dividend feature is its unsung hero. Unlike non-cumulative preferreds, missed distributions accrue and must be paid before common shareholders receive a dime. This is critical in an energy sector where cash flows can swing wildly. Even if NGL were to cut distributions—a rare occurrence thus far—the cumulative obligation ensures eventual payout. Recent data shows no skipped payments, with distributions remaining intact despite broader sector yield reductions.

The Contrarian Case: Why Now?

Investors may balk at energy midstream preferreds due to sector volatility. Yet, NGL.PRC's $4.08 discount to par and 13.26% yield position it as a contrarian bet on two outcomes:1. Reversion to Par: If NGL's operations stabilize (as hinted by its $622.9M Adjusted EBITDA in FY2025), the price could climb toward $25, boosting total returns.2. Dividend Resilience: Cumulative terms and the floating rate's fixed spread provide a buffer against macro shocks.

Risks to Consider

• LIBOR Transition: The use of Three-Month LIBOR in the floating rate formula is a red flag, as LIBOR's discontinuation looms. While the prospectus may pivot to SOFR, any recalibration could disrupt payout predictability.
• Energy Sector Volatility: NGL's crude oil logistics and water solutions businesses are tied to commodity prices. A prolonged downturn in oil prices could strain cash flows.
• Redemption Risk: Though the call date passed in April 2024, NGL could still redeem units at $25. A buyback would cap upside but ensure investors receive the liquidation preference.

Investment Thesis: Strategic Income Allocation

For income-focused portfolios, NGL.PRC deserves consideration as a high-yield satellite position. The 13.26% yield, cumulative dividends, and floating rate stability outweigh near-term risks for investors with a 2–3 year horizon. A 5–10% allocation in a diversified preferred portfolio could generate outsized income while hedging against broader market dips.

Conclusion

NGL.PRC is not for the faint-hearted. Its yield reflects genuine risks in an uncertain energy landscape. Yet, the discount to liquidation preference, cumulative protections, and floating rate mechanics create a compelling risk-reward profile. For contrarians willing to endure volatility, this security offers a chance to capitalize on a market mispricing—a rarity in today's yield-starved environment. Proceed with caution, but proceed.

Final Note: Monitor Three-Month LIBOR trends and NGL's quarterly updates for dividend clues. Avoid overconcentration unless aligned with your risk tolerance.