What 1 Key Metric Says About These 3 Popular MLPs

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. For example, instead of the traditional P/E ratio we emphasize MLP-specific metrics like distribution coverage ratio, and today's focus: price to distributable cash flow (P/DCF). I'll use Energy Transfer Partners (NYSE: ETP  ) , Oneok Partners (NYSE: OKS  ) , and Magellan Midstream Partners (NYSE: MMP  ) as our three examples.

Why this metric?
Price to distributable cash flow is the MLP metric that comes closest to the P/E ratio most investors know and love. Like any good ratio, it allows you to compare MLPs on a relative basis, regardless of size.

Distributable cash flow per unit replaces earnings per unit in these relative valuations because MLPs pass through almost all of their cash to unit holders. Distributable cash flow drives distribution growth, which in turn drives unit prices. That's really what investors care about the most with MLPs, and that's why analysts and management never discuss earnings per share for their MLPs; it's all about distributable cash flow.

How the metric works
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 Energy Transfer Partners as our first example. We'll use distributable cash flow numbers from the four most recent quarters. The numbers shake out like this:

Q1 2014

Q4 2013

Q3 2013

Q2 2013

Total

 $629

 $530

 $511

 $418

 $2,088

Source: MLPData.com. Dollar figures are in millions.

Now we'll divide the partnership's market cap by $2.09 billion to derive our P/DCF multiple:

Market Cap

DCF

P/DCF

$17.84

$2.09

8.5x

Source: MLPData.com, Yahoo! Finance. Dollar figures are in billions.

The whole point of this exercise is relative valuation, so let's see how Energy Transfer's multiple compares to some of its peers. The DCF numbers for Oneok Partners and Magellan Midstream Partners come from the same four quarters that we used for Energy Transfer.

MLP

Market Cap

DCF

P/DCF

ETP

$17.84

$2.09

8.5x

OKS

$12.71

$1.06

12.0x

MMP

$17.87

$0.80

22.3x

Source: MLPData.com, Yahoo! Finance. Dollar figures are in billions.

Oneok Partners falls right in the middle here, and, 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 analysts at Morgan Stanley and Wells Fargo, the average multiple for large cap MLPs like today's group has been between 15 and 16 time price to distributable cash flow .

By that standard, Energy Transfer Partners and Oneok Partners are both "cheap" here, while investors could probably stand to wait for a cheaper buy-in price for Magellan Midstream Partners.

So where to from here? Often MLPs will sport low P/DCF multiples because there has been a sell-off, or some other balance sheet tragedy, so interested investors need to make sure that's not the case here. Oneok has had a rough go of the low price environment for natural gas liquids over the past few years, and as a result, its distribution growth has been mediocre. That said, it has maintained coverage of that distribution for the past twelve months, and we have certainly seen MLPs with far less to offer than Oneok Partners.

Energy Transfer Partners has begun to right its ship, achieving distribution coverage in the third quarter of last year, and increasing its distribution for the first time in a half a decade shortly thereafter. Investors remain wary of the MLP, however, and its units are in the red year-to-date; that helps explain why its current P/DCF multiple is so low, despite a 50% increase in distributable cash flow over the past year.

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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