This MLP Is Crazy Expensive, but Is It Worth the Price?

Phillips 66 and Valero both recently launched master limited partnerships. These MLPs have grown in price at an impressive rate. At their current price relative to distributable cash flow, are these MLPs worth their going price?

Jul 6, 2014 at 9:58AM

Energy-related master limited partnerships, or MLPs, offer investors a great way to cash in on the growth of U.S. energy production. MLPs come in different flavors. Some offer high yields that may not grow over time. Others offer a relatively low initial yield, but with a strong history of growing distributions. One way to determine the value of an MLP is to calculate its price to distributable cash flow, or P/DCF. This is done by dividing the market capitalization of the MLP by its annual distributable cash flow. A generally reasonable ratio is around 16.

Not too long ago, both Valero and Phillips 66 launched their own respective MLPs. Both of these started by paying a yield of roughly 2% -- not the sort of yield that causes investors to stampede a stock. Yet, both MLPs have done nothing but go up. Valero Energy Partners, LP (NYSE:VLP) units are up 77% over the past year, and Phillips 66 Partners LP (NYSE:PSXP) is up over 160% over the past year, with most of that gain in the past five months or so. One driver of Phillips' capital gains has been its distribution growth. Specifically, Phillips has increased its distribution from $0.155 to $0.274 in three quarters. Valero has made only one payment so far. With the run-up in their respective unit prices, are these MLPs overpriced, or not?

By the numbers
Since both MLPs are relatively new, we'll annualize the distributable cash flow from each company's latest earnings report. Phillips Partners reported $23.3 million in distributable cash flow, Valero Partners, $16.6 million. This works out to $93.2 million for Phillips, $54.4 million for Valero. Divide each company's market capitalization by its annualized distributable cash flow, and Phillips has a P/DCF of 61.8 and Valero, 52.6. Not cheap by any means.

Put another way, in order for Phillips to achieve a P/DCF of 16, it would have to increase its distributable cash flow 15-fold. Valero would have to increase its distributable cash flow 13-fold.

What is driving these valuations?
Both of these MLPs have short track records, Valero particularly. What do they offer investors to justify such a high premium? First, it's not yield. Currently, Phillips yields 1.44% and Valero 1.73%. Distribution growth, as mentioned before, is impressive for Phillips, but so far short-lived.

Most likely, investors are looking at their business model. Both MLPs have contracts with their parent companies to ship crude oil, refined products and natural gas liquids from company-owned terminals to refineries. That is, they have captive markets. These are fee-based contracts, so there is no direct exposure to volatile energy prices. The parent companies are well-established companies that aren't disappearing anytime soon. Both parent companies look to expand the scope of their MLP operations. Which is all to say, revenues and distributable cash flow should keep growing for both Phillips and Valero Partners.

Are they worth it?
I'm inclined to say no. While their business model seems to virtually guarantee success, for a starting yield of under 2%, no meaningful track record of distribution growth, and a sky-high P/DCF, I can't see these MLPs being a good investment at this time. A great deal of expectation is built into the price of both MLPs, and I can see a significant drop in unit price if distribution growth disappoints.

An alternative investment
Instead of paying a premium for Phillips or Valero MLPs, I would look at Williams Partners LP (NYSE:WPZ). This MLP was spun off of Williams Companies in 2005, currently pays a 6.7% yield, and sells for a P/DCF of about 10. In 2010, the distribution started at $0.635 per unit and rose every quarter since. Today, the payout is $0.905 per unit.

Williams operates a large network of natural gas and natural gas liquids pipelines and other midstream services. These assets connect some of the best sources of natural gas to some of the biggest markets in the U.S. These assets recently expanded with the recent announcement that Williams Companies acquired more assets from Access Midstream Partners. The parent company proposes transferring Access assets to the MLP, thus significantly expanding the scope of Williams' operations. There is some debate regarding the wisdom of this transaction, but given the response of the stock to the news, investors seem to like the deal for Williams.

Final Foolish thoughts
Investing in MLPs allows investors to benefit from the growing U.S. energy business. Like the price to earnings ratio for corporations, the P/DCF helps investors assess the value of an MLP. For both Phillips and Valero MLPs the ratios are much higher than average, with little yield or track record to justify their prices. No doubt both MLPs have solid business plans and will grow their distributions. Given their low yields and short track records of distribution growth, I would go elsewhere until distributable cash flow catches up to the price.

Do you know this energy tax "loophole"?
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven’t heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America’s greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, “The IRS Is Daring You to Make This Investment Now!,” and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

 

Robert Zimmerman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers