Interest rates are at a generational low and investors are scouring the markets looking for yield. One of the main places they're turning to is the master limited partnership, or MLP, asset class.
MLPs are predominantly in the energy space, with most of them engaged in midstream operations, such as transporting and storing commodities like crude oil, natural gas, natural gas liquids, and refined product. Within the sector, one company that's mainly involved in gathering and processing natural gas looks especially promising.
MarkWest marks the spot
I'm talking about Colorado-based MarkWest Energy Partners (NYSE: MWE ) . It's a master limited partnership primarily engaged in gathering, processing, and transporting natural gas, as well as transporting, fractionating, and storing natural gas liquids, or NGLs, and gathering and transporting crude oil.
The company has a dominant presence in several major natural gas producing regions in the country, many of which are poised for high growth. It's currently the largest processor in the Marcellus and Huron shales, as well as the largest fractionator in the Appalachian region. And the company has inked long-term contracts with oil and gas producers to further develop the Marcellus and Utica shales, the Huron/Berea Shale, the Woodford Shale, the Haynesville Shale, and the Granite Wash formation.
A focus on high-growth regions
While a good chunk of MarkWest's growth in recent years has been acquisition-led, the company also has numerous plans for organic growth. Currently, its focusing on expanding its Liberty operations in Pennsylvania and West Virginia, which includes the famous Marcellus shale, as well as on finishing up the first phase of its Utica operations. Both should continue to drive strong cash flows and distribution growth for years into the future.
In the Marcellus, the company's main focus is on expanding its gathering system to support the development of the highly prolific play. As new wells are brought online in the second half of the year, gas volumes should continue to boom. In fact, the company expects total volumes in the Marcellus to approach 1 billion cubic feet per day by year's end.
And in the Utica, MarkWest has entered into a joint venture with The Energy & Minerals Group to develop midstream infrastructure in the liquids-rich portion of the play, with The Energy & Minerals Group to fund the first $500 million of capital expenses. It also recently had an agreement with Gulfport Energy Corporation to provide gathering, processing, and fractionation services in the region.
MarkWest currently yields 5.9%, which is on par with the average MLP's payout. For the second quarter, its distributable cash flow rose 10% from the year-earlier quarter to $91.2 million. Similarly, its distribution increased 14% from the year-earlier period, coming in at $0.80 per common unit. However, the distribution coverage ratio was an uncomfortably low 1.03 times.
One factor that's key in selecting individual MLPs is distribution growth. Investors should look for companies that have increased their distributions consistently over the years and have the financial strength to continue increasing their payouts. In this regard, MarkWest stacks up nicely.
Since it went public in 2002, the company has grown its distribution by 220% in total, which comes out to a 12% compounded annual growth rate. Annual distributions have grown each year since the company's IPO.
A stable business model
One thing I really like about MarkWest is its continued progress in increasing its fee-based margin. Fee-based contracts are one of the most attractive aspects of MLPs' business models, since they provide a great deal of stability and predictability of cash flows and, hence, distributions.
For instance, companies like Enterprise Products Partners (NYSE: EPD ) , Kinder Morgan Energy Partners (NYSE: KMP ) , and Plains All American (NYSE: PAA ) all derive the bulk of their revenues from fee-based contracted assets. MarkWest isn't there yet, but it's getting there.
While just 44% of its net operating margin was fee-based as of the end of the second quarter, this share is set to rise substantially over coming years. The main reason is because the vast majority of its new growth projects are secured by fee-based contracts. By year's end, the company projects its percentage of fee-based contracts to rise to 50%, and by 2014, to 60%.
This is reflective of a broader trend among MLPs. Since upstream operations tend to have greater exposure to commodity prices than midstream operations, companies are increasingly shifting their focus toward the midstream business segment. For instance, Energy Transfer Partners (NYSE: ETP ) is expecting its midstream segment to grow substantially as a percentage of its overall business mix, with a large number of fee-based projects set to come online over the next year.
Overall, I really like what I'm seeing from MarkWest. It has a high-quality portfolio of midstream assets with a broad geographic span, many of which produce stable and predictable revenues based on long-term, fee-based contracts. And the fact that its share of fee-based assets is set to rise substantially in the next couple of years bodes well for cash flow stability and further distribution increases.
As you can see, MLPs like MarkWest play a necessary role in our booming domestic oil and gas market. But, they're not the only game in town. Energy services and equipment companies are a crucial part of the picture, as well. In fact, one oil and gas equipment provider is the top pick this year among our analysts here at the Fool. You can read more about this company and why it's ready to soar in The Motley Fool's special free report: "The Only Energy Stock You'll Ever Need." Don't miss out on this limited-time opportunity to discover the name of this company. Click here to access your report – it's totally free.