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Why DCP Midstream Plunged More Than 25% in 2018

What happened

Last year was a tale of two periods for DCP Midstream (NYSE: DCP). Units of the midstream MLP were up double digits for most of the year, peaking at a more-than-25% gain in August.

However, the final quarter of 2018 was a brutal one, as DCP Midstream sold off with the rest of the oil market. Overall, the midstream company lost 27.1% of its value last year, according to data provided by S&P Global Market Intelligence. Here's a look at why the high-yielding MLP was so volatile in 2018.

Image source: Getty Images.

So what

DCP Midstream delivered strong financial results in each of the first three quarters of the year. As a result, its distributable cash flow was up about 17% compared to the first nine months of 2017, driven by strong volume growth thanks to the impact of a red-hot oil market and recently completed expansion projects. That strong start to 2018 had DCP Midstream on pace to exceed the high end of its full-year forecast.

However, the fourth quarter of 2018 was a different story, as crude prices plummeted 40% from their peak in early October, falling 19% for the year. Driving that decline was a shift in market sentiment. The industry went from worrying that there wouldn't be enough supply to meet demand once the U.S. reimposed new sanctions on Iran to fretting that there was too much oil sloshing around after the Trump administration granted waivers to most of Iran's key customers so that they could continue buying oil.

That plunge in the oil market hit DCP Midstream harder than it did most rivals. That's because the company gets about 40% of its earnings from commodity-based margins, which is well above the 10% target of most peers. While DCP Midstream utilizes hedges to lock in prices on about half this income, the slump in oil prices likely cut into its cash flow during the final quarter of 2018 and will impact it in 2019 unless prices improve.

Now what

DCP Midstream is working to reduce its direct exposure to commodity prices not only through hedging but by investing in building more fee-based assets. The company currently has several pipeline projects underway that should enter service in 2019. As they do, they'll enhance the long-term stability of its 9.6%-yielding distribution, which would make it a more compelling option for income-seeking investors.

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

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