5 Very Different Midstream MLP Opportunities

Master limited partnerships are designed to spill cash -- the more the better, right? How can you tell how safe that big distribution really is? Investors need to watch coverage ratios, just like any other dividend-bearing stock.

Unfortunately, comparisons can still be tricky. While yields and coverage ratios can be useful for apples-to-apples comps, bear in mind that comparing a McIntosh to a Granny Smith is not always as straightforward as it seems. There's more variety in this group than first appears.

These aren't just any old C-Corps
Because of their tax-exempt status, MLPs can distribute more than seems possible. To clarify their accounting for investors, most MLPs use non-generally accepted accounting principles numbers for guidance. The single most important metric to follow is distributable cash flow. In a nutshell, it's all the cash produced that management thinks it doesn't need to keep the roof up.

Look for more coverage than a Speedo
To make sure you're not left out in the cold if things go wrong, you need to monitor the gulf between DCF and the distribution. Large distributions are nice, but the best distribution is a safe one. If your partnership is shelling out more cash than it can afford, a hiccup will mean a cut, and cuts can be devastating. Income investors hate unpleasant surprises, and it's easy to get stampeded if the herd bolts from a name.

Partnerships present coverage ratios for their distributions. They're simply the ratio of DCF to the total cash paid out. Combed through reports and presentations give you a feel for how different these partnerships really are. Below are the numbers for the midstream MLPs with market caps of more than $10 billion.

The compounded annual growth rate for distributions since the credit crisis was calculated using March 2, 2009 as the low. Total returns (distributions plus capital gains) for one year and the post- credit crisis period are also shown. Yields are annualized current yields. Coverage ratios were obtained from company presentations (WPZ, EPD, OKS) or calculated from the last quarter's SEC form 10-Q (KMP and MMP). Some data for ONEOK are excluded because the partnership is too young (labeled "n.a." in the table).

There's surprising variety in coverage levels.
Most carry more than adequate wiggle room, but a couple are spread pretty thin. Williams Partners (NYSE: WPZ  ) provides a nice 7% yield, yet its coverage ratio suggests reason for concern. Paying out more than you bring in can only go on for so long. On the positive side, its general partner agreed to waive up to $200 million of its IDR payments to support the distribution if needed. It hasn't been needed to date, but the fact that it's out there is comforting.

Soft natural-gas liquids (NGL) margins and a severe accident at its Geismar olefin plant affected the quarter, so Williams might deserve a pass. These problems aren't systemic. Forward guidance is for strong growth, so believers in its plans could be looking at a buying opportunity.

Kinder Morgan Energy Partners (NYSE: KMP  ) is embroiled in a short attack, but unit weakness actually preceded that attack. It also sports a strong 7% current yield. Coverage stands at a strong 1.5 times DCF. The Kinder Morgan family is the single-largest MLP group out there. Its sheer size implies that growth will be challenging. While the distribution appears safe, that challenge may explain why some of the smaller partnerships are currently outperforming Kinder Morgan Energy Partners.

A smaller distribution is easier to swallow in high-growth names
Enterprise Products Partners (NYSE: EPD  ) is another venerable, trusted name. Over the years, it's had some of the most conservative coverage ratios in the space, accounting for its premium to peers. Like Kinder Morgan, its size makes growth more challenging than smaller peers, but that size, its strong balance sheet, wide coverage, and consistent growth are exactly what conservative investors have come to trust. They'll pay up for the track record.

Two of the more interesting names to pop out are smaller, higher-growth opportunities. High growth can translate to vastly greater total-return potential even if current yields appear weaker. The top names in five-year returns are those that grew their distributions the most, despite carrying lower yields. That retained capital is what fuels their growth. Enterprise is an excellent example of how lower yield and growth can drive higher returns over time.

A younger, smaller partnership with that trait is Magellan Midstream Partners (NYSE: MMP  ) . Magellan's historical 4% yield looks less appetizing than its competition, but its 10% distribution CAGR since the credit crisis made it the top performer in total return. That shouldn't change as management's forward guidance is for 16% and 15% distribution growth in 2014 and 2015, respectively. If anything, its extremely conservative coverage suggests there's room for even more growth than that.

Finally, there's relative newcomer ONEOK Partners (NYSE: OKS  ) . It has an impressive pile of capital expenditures planned to drive growth 15%-20% annually over the next three years. That's the kind of growth that really drives returns over time.

Interestingly, ONEOK Partners' units have struggled lately. Results were impaired by poor NGL pricing, and interest rate worries only compounded investor concerns. Its coverage is fine and given its growth potential, investors may want to take a second look at the name.

An opportunity for every goal
There's a surprising array of opportunities in the MLP segment. Opportunities range from straight forward high yield, like Kinder Morgan, to growth-at-a- reasonable-price names like Enterprise Products. Special situations like Williams Partners with its short-term challenges may be of interest to some. Even the high- growth crowd has names like Magellan and ONEOK that are worth a look.

Grabbing the highest yield isn't always your best bet, even in high-quality names like these. Consider those coverage ratios and long-term growth potential to maximize your total return.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 25, 2013, at 9:38 AM, 95dollarbill wrote:

    The right margin of this article is cut-off making it impossible to understand.

  • Report this Comment On September 25, 2013, at 10:22 AM, fredjohnson55343 wrote:

    You cut off the right margins. We don't know what you are saying.

  • Report this Comment On September 25, 2013, at 11:22 AM, JustMee01 wrote:

    Hey guys,

    Thanks for pointing that out. For some reason it's a PC-only problem. Tablets are OK. Working on it...

  • Report this Comment On September 25, 2013, at 3:40 PM, 95dollarbill wrote:

    Just an update: 3:40 pm EST it's still not working for PCs. Interesting article.

  • Report this Comment On September 25, 2013, at 5:41 PM, mfm304 wrote:

    actually, it is truncated for Macs, as well.

  • Report this Comment On September 25, 2013, at 5:41 PM, JustMee01 wrote:

    It's fixed. Thanks for your patience.

  • Report this Comment On September 26, 2013, at 9:06 AM, TMFAimeeD wrote:

    What numbers are you using for KMP's coverage ratio? It didn't clear 1.0 in the second quarter, per the filing and the CFO on the conference call.

    Aimee

  • Report this Comment On September 26, 2013, at 10:40 AM, JustMee01 wrote:

    Hi Aimee,

    Hmmm.

    I calculated KMP's coverage ratio from the 10-Q. They reported $505MM of DCF for Q2 on page 55.

    And on the cash flow statement, they reported $695MM of distributions to common, class B and non-controlling interests. That's a 6 mos. number. So, I backed out the Q1 distribution of $342MM paid to unitholders.

    DCF = $505

    Dist = $695 - $342 = $353

    505/353 = 1.43

    Can't explain the discrepancy, unless... In their presentation of DCF in the Q, they exclude the GP's interest of Net Income. This is unusual.

    So, I excluded the GP's distribution from the coverage ratio. Perhaps that's incorrect. I presumed that since they excluded the GP interest in Net Income, then GP distributions should be excluded from the coverage ratio.

    If the GP distribution is included, then KMP is indeed upside down on their coverage ratio. The GP distribution was $404MM in Q2.

    Another possibility is that they're excluding non-recurrent income from their presentation.

    Can you point me to where they present the ratio in the 10-Q, or was this from a slide deck for the quarter? I can't find it in the Q2 press release either. I'd like to understand why it's off.

    Thanks,

    Peter

  • Report this Comment On September 26, 2013, at 11:04 AM, TMFAimeeD wrote:

    If you search the transcript for "coverage" you'll find the part where Kim Dang explains DCF generated of $1.22 per unit, but paid $1.32 per unit.

    http://seekingalpha.com/article/1554412-kinder-morgan-energy...

    In the press release, if you multiply the declared distribution [$1.32] by the weighted average units outstanding [413] you get $545 million. So $505 M in DCF / $545 M paid out = .93 coverage

    http://phx.corporate-ir.net/phoenix.zhtml?c=119776&p=iro...

    The $40 M discrepancy also matches what Dang said on the call.

    This is the downside to non-GAAP!

    Aimee

  • Report this Comment On September 26, 2013, at 1:09 PM, JustMee01 wrote:

    Aimee,

    Dang! I wish they showed that calculation somewhere. It would make life a lot easier.

    At $1.32 per share and 413 MM units, the $505 they show is way above the cash flow statement ($336).

    The share count of 413 MM cited is also much higher than the common share count. KMP shows 307 MM of common and 119 MM iUnits quarter end. That 426 MM quarter end number fits better with the weighted average number you cite, so the distribution they show must include the distribution to iUnits (i.e. to KMR).

    Perhaps there is some amount of that $505 that's non-cash that they include in the coverage calculation.

    Looking at it that way, there were 116 MM iUnits x $1.32 = $153 MM non-cash distribution to KMR holders. Add the $336 of cash distributions and you get $489. The remaining distributions to the B shares and non-controlling interests add $17 MM getting you to $506 MM. That’s well within rounding error.

    So, the discrepancy must be the distribution to KMR. The KMP iUnits held by KMR don't pay in cash. They pay in units, of course. However, it was my understanding that KMR was a holdco that was given a cash distribution. It then issued new KMR shares in lieu of that distribution and bought in KMR shares throughout the quarter to eat up the dilution. I thought there was still a cash transaction between business units that would appear on the cash flow statement.

    That incorrect understanding led me to conclude that the “common distribution” shown was KMP + iUnits. Apparently that’s wrong.

    Kinder-Morgan is a much more complicated entity than most of the other partnerships. Most have a much simpler capital structure.

    Thanks for speaking up,

    Peter

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