You Should Consider These Energy MLP Spin-Offs

Oil refiners like Valero Energy and Marathon Petroleum are setting their midstream assets free as Master Limited Partnerships, which give investors a new way to capitalize on the U.S. energy boom.

Feb 26, 2014 at 11:02AM

Oil and gas Master Limited Partnerships are all the rage these days, and for good reason. These companies own energy midstream assets, which include oil and gas pipelines, storage terminals, and other treatment facilities. Oil and gas MLPs offer investors dual benefits.

First, they provide access to energy infrastructure which is in high demand these days thanks to the oil and gas boom in the United States. As production accelerates, all that oil and gas needs to be treated and transported. That's where midstream MLPs come in.

Next, because they enjoy a favorable tax classification, MLPs are required to distribute the bulk of their cash flow to investors. This means MLP investors receive hefty income yields. And, since their services are generally fee-based and not vulnerable to volatile swings in commodity prices, those big cash payouts are fairly safe and secured by underlying cash flow. That's why investors with an eye for growth and income should consider these newly spun-off midstream MLPs.

Setting midstream assets free
Oil refiners like Valero Energy (NYSE:VLO) are cutting their midstream assets loose to focus on their own refining, marketing, and other downstream activities. The over-arching strategy employed by management is that the sum of the parts is worth more than the whole. Since refining has been such a difficult business over the past year, due to shrinking margins on refined product sales, better-performing midstream assets were getting overshadowed. For example, Valero Energy's operating income actually declined by 1% in 2013, reflecting weak refining throughput margins.

Valero Energy spun off Valero Energy Partners (NYSE:VLP) very recently, in December 2013. Valero Energy Partners operates the midstream assets, which include crude oil and refined petroleum product pipelines and terminals. In a recent presentation, Valero Energy management stated its belief that the spin-off was crucial to unlocking greater value of its existing portfolio assets.

Spin-off strategy appears to be working
These types of spin-offs have a track record of recent success. One example is MPLX LP (NYSE:MPLX), which broke off from refiner Marathon Petroleum Corp. (NYSE:MPC) in October 2012. The first thing that may strike potential investors is MPLX's relatively low yield, which stands at approximately 2.5% annualized. That isn't much higher than Marathon's dividend, which clocks in at about 2%.

An interesting caveat to this situation is that management considers MPLX to be a growth-oriented MLP. That means the focus is on aggressive volume growth. Management wants to pursue investment in new assets as much as possible, which the company believes will ensure higher future growth of cash flows and distributions.

Even though MPLX has only paid five quarterly distributions since its initial public offering, it's clear that management's strategy is working. MPLX has raised its distribution every quarter so far. The underlying business is growing strongly as well. In the fourth quarter, MPLX grew distributable cash flow by nearly 70%, which management attributed specifically to booming North American crude oil production.

As a result, this spectacular growth is what allowed MPLX to increase its first quarter distribution by 77% versus the same distribution in 2013. Going forward, rapid distribution growth is expected to continue. Management has previously stated its intention to raise distributions by 15%-20% annually over the next several years.

New MLPs are pumping out profits and distributions
Management teams of refining and marketing companies Valero Energy and Marathon Petroleum decided in recent years to set free their midstream assets as independent partnerships. Since their IPOs, Valero Energy Partners and MPLX, which operate pipelines and storage facilities, have given investors another option to capitalize on the domestic energy boom.

Investors have the opportunity to tap into just their midstream assets, which are performing much better right now than Valero's and Marathon's refining businesses. And, the MLPs will pump out growth and increasing distributions to investors for many years, due to reliable, fee-based cash flows.

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