How to Value MLPs: Price to Distributable Cash Flow

Master limited partnerships are not like other stocks, and the metrics we use to compare an MLP to its peers differ from the metrics we use to compare regular companies. The P/E ratio is out. Instead, we emphasize MLP-specific metrics like enterprise value to EBITDA (EV/EBITDA), distribution coverage ratio, and today's focus: price to distributable cash flow (P/DCF).

How the metric works
Price to distributable cash flow is the MLP metric that comes closest to the P/E ratio most investors know and love. Distributable cash flow per unit replaces earnings per unit in our relative valuations because MLPs pass through almost all of their cash to unitholders. Distribution growth drives unit prices, and it's really all anyone cares about. That's why analysts and management never discuss EPS with MLPs; it's all about distributable cash flow.

To calculate P/DCF you take the market cap of the MLP and divide it by a full year of distributable cash flow.

Let's use Enterprise Products Partners (NYSE: EPD  ) as our first example. We'll use distributable cash flow numbers from the four most recent quarters. The numbers shake out like this:

Q2 2013

Q1 2013

Q4 2012

Q3 2012

Total

$925

$897

$886

$743

$3,451

Source: Company filings, Google Finance. Dollar figures are in millions .

Now we'll divide the partnership's market cap by $3.45 billion to derive our P/DCF multiple:

Market Cap

DCF

P/DCF

$57.10

$3.45

16.55x

Source: Company filings, Google Finance. Dollar figures are in billions

The whole point of this exercise is relative valuation, so let's see how Enterprise's multiple compares to some of its peers. The DCF numbers for Energy Transfer Partners (NYSE: ETP  ) and Kinder Morgan Energy Partners (NYSE: KMP  ) come from the same four quarters that we used for Enterprise.

MLP

Market Cap

DCF

P/DCF

Energy Transfer Partners

$19.59

$1.89

10.37x

Kinder Morgan Energy Partners

$34.68

$2.01

17.25x

Enterprise

$57.10

$3.45

16.55x

 Source: Company releases, Google Finance. Dollar figures are in billions.

Enterprise falls right in the middle here. Not surprisingly, given its distribution history, Energy Transfer Partners has the most room to run.

But what is the benchmark for this cash flow multiple anyway? Most investors have heard that a P/E ratio greater than 15 is high, and the further it floats above that magic number the more overvalued the stock is. According to Morgan Stanley, the historical average for MLPs is right around 13 times distributable cash flow, with a standard deviation of plus or minus two. For the past two years the average has been at or above 15 times DCF.

By that standard, Energy Transfer Partners is the only MLP here that is "cheap." While investors could probably stand to wait for a cheaper buy-in price for Enterprise and Kinder Morgan, neither is hideously inflated right now.

Bottom line
Again, the P/DCF ratio is useful for relative valuations, but by no means would you want to base your entire investing thesis on this one metric alone. In that regard, it is exactly like the P/E ratio: a great place to start your search.

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