3 Exceptional MLPs Poised for Strong Distribution Growth

For income investors, pipeline master limited partnerships (MLPs) offer great ways to achieve, high, safe, and growing yields with capital gains to boot. The nature of these MLPs is that 87% of them have general partners who manage the partnership and often drop down valuable assets at favorable prices. In a previous article I outlined the differences between general partners and their MLPs, but this article is designed to address the belief by many MLP investors that general partners eventually become a drag on distribution growth. 

A general partnership stake in an MLP is typically worth 2% of the MLP's cash flows. The incentive distribution rights, (IDRs) are designed to provide an incentive for the gp to raise the distribution. This is because above certain, predetermined distribution levels, the general partner will receive up to 50% of any additional distributable cash flow (DCF). Thus IDRs are the primary way gps make money from their MLPs, and oftentimes a general partner will act as a financier to its MLP, purchasing valuable assets, then selling them to their MLP in exchange for cash, taking on the general partner's debt, and additional limited units. 

As an example of how quickly these IDRs can grow, consider this. A general partner in an MLP that raises its distribution rate by 6% annually, will result in a 16% compound growth rate in IDR fees for the general partner. This is why general partner stocks (which are often publicly traded) can make great dividend growth stocks. On the flip side, the risk of income loss to the general partner is enormous, because a 25% distribution cut by the MLP would result in a 82% loss in IDRs and a 50% distribution cut would result in a 95% income loss.

This creates a beneficial relationship between general partners and their MLPs, because the gp has such a strong financial incentive to protect and grow the MLP's distribution. However, many investors argue that past a certain point a general partner becomes a drag on the performance of the MLP. This is primarily because, with 50% of marginal DCF going to the gp instead of limited partners, distribution growth for mature MLPs such as Kinder Morgan Energy Partners is generally slower than MLPs without general partners, such as Enterprise Products Partners  (NYSE: EPD  ) , Magellan Midstream Partners  (NYSE: MMP  ) and MarkWest Energy Partners  (NYSE: MWE  ) . In addition, MLPs without general partners usually trade at a premium (Magellan trades at a 137% premium to Kinder Morgan on a price/DCF basis), resulting in a lower yield.

MLP Yield 12 yr distribution growth rate (CAGR) 14 year Total Returns (CAGR)
KMP 7.30% 7.04% 13.10%
EPD 3.80% 6.33% 16.80%
MWE 5.60% 15.62% 25.20%
MMP 3.00% 11.39% 25.40%
S&P 500 2.07%   6.10%

Source: Fastgraphs

As seen above, all four midstream MLPs have crushed the market's total returns over the long-term, but those without a general partner performed much better. The higher yield makes Kinder Morgan worth considering, but for the rest of this article I would like to highlight my favorite three gp-free MLPs and why income investors should consider them.

The best gp-free MLPs
A recent study by ICF concluded that by 2024 U.S. demand for natural gas will increase by 47%. By 2030 $641 billion in additional energy infrastructure will be required to support America's energy boom. This creates immense growth opportunities for all three of of the following MLPs.

Enterprise Products Partners is the largest midstream MLP by enterprise value and has a record of 40 consecutive quarterly distribution raises. This "old faithful" of distribution increases has a 16-year, 7% CAGR track record and analysts at S&P Capital IQ are projecting a 7.2% CAGR growth rate over the next decade. This growth will be fueled by the company's heavy investment in LNG (liquified natural gas) and NGL (natural gas liquids) exports, which are expected to increase by 79% through 2020.

Magellan Midstream Partners' distribution growth rate is the most impressive of any MLP I've seen. Since 2001 the distribution growth has been 12% CAGR, with 16% growth in 2013 and management guiding for 20% growth in 2014 and 15% in 2015. In the last quarter, management raised the distribution by 21%, beating its already aggressive guidance. With its long track record of exceptional accretive acquisitions and organic investments, I expect Magellan's phenomenal performance to continue for many years. 

MarkWest Energy Partners is the best MLP play on the booming Marcellus shale gas formation, with a 20-fold increase in production from 2007 to 2015-2018. With nearly 20% of gas processing capacity in the Marcellus (86% capacity growth planned) and fee-based margins of 70% and growing, it's easy to see why analysts are projecting 62% CAGR EPS growth over the next decade (distribution growth 37% CAGR).

Foolish takeaway
Gp-free midstream MLPs can offer investors immense opportunities for market-beating total returns. Enterprise Products Partners, Magellan Midstream Partners and MarkWest Energy Partners are the best of breed in this investment area, with long track records of superior management and disciplined growth. They will likely continue to deliver superior returns to long-term investors for many years to come and should be considered for a position in any income portfolio. 


Read/Post Comments (5) | Recommend This Article (3)

Comments from our Foolish Readers

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 May 29, 2014, at 3:59 PM, ferdiefor wrote:

    The author should have at least offered commentary about the fourth best MLP without a GP and that is GEL which is considered by many to be a miniature version of EPD.

  • Report this Comment On May 29, 2014, at 6:06 PM, AdamGalas wrote:

    Thank you for the comment. I'll make sure to look at GEL and write it up in the future.

  • Report this Comment On May 29, 2014, at 6:07 PM, AdamGalas wrote:

    If its anything like CMLP, but without a GP, then that would be an exciting investment opportunity.

  • Report this Comment On May 29, 2014, at 7:16 PM, ferdiefor wrote:

    CMLP has been a major disappointment. It now appears that merging two mediocre MLPs having assets of questionable value has led to the formation of an even larger mediocre MLP. I had high hopes that CMLP's CEO, a former EPD division CEO had the right stuff but it appears he is burdened with an asset base that hampers growth opportunities. Now it appears Inergy overpaid for the St. James assets and are unable to grow them the way others in that area including PAA are growing.

  • Report this Comment On May 29, 2014, at 11:26 PM, AdamGalas wrote:

    Thank you so much for your insightful and well argued comments. Your concerns are certainly something I'll keep in mind for my follow up to my previous article about CMLP.

    Like you, my hope was that a former CEO of EPD could recreate the kind of midstream empire, but from a smaller size and thus stronger short-term to medium-term growth.

    It would be a disappointment to find that was not the case, but if true, more important to let Motley Fool readers know of superior alternatives.

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