Source: Tallgrass Energy Partners.
It's no secret that the worst oil crash in 50 years has crushed almost all energy stocks. Even super-fast-growing midstream MLPs such as Tallgrass Energy Partners (NYSE: TEP) haven't been spared Wall Street's wrath.
Despite some of the fastest distribution growth in its industry -- management just raised the quarterly payout 46.3% year over year -- investors may understandably be concerned about whether Tallgrass Energy Partners' future growth prospects can survive the collapse of energy prices. Perhaps more importantly, investors need to know whether this midstream MLP is a better long-term value at today's price than other super-fast-growing competitors such as Phillips 66 Partners (NYSE: PSXP), MPLX (NYSE: MPLX), Shell Midstream Partners (NYSE: SHLX), and Valero Energy Partners (NYSE: VLP).
To help answer these questions, let's examine three important factors that are likely to determine whether Tallgrass Energy Partners can keep its impressive growth streak alive in a world of low energy prices and is thus potentially worthy of a spot in your diversified income portfolio.
Valuation is very appealing but ...
| Company | Forward Yield | EV/EBITDA | Price/Operating Cash Flow |
|---|---|---|---|
| Tallgrass Energy Partners | 6.8% | 12.2 | 8.3 |
| Phillips 66 Partners | 3.1% | 35.4 | 23.1 |
| MPLX | 6.3% | 12.2 | 10.7 |
| Shell Midstream Partners | 2.5% | 35.7 | 27.5 |
| Valero Energy Partners | 2.6% | 20.0 | 18.5 |
Sources: Yahoo! Finance, Fastgraphs.
Tallgrass Energy Partners is currently the cheapest of these fast-growing midstream MLPs, while Phillips 66 Partners and Shell Midstream Partners are the two most richly valued. However, a long-term income investment thesis doesn't consist of valuation alone, but also on payout sustainability and long-term growth prospects. From that perspective it becomes clear why Tallgrass Energy Partners is trading so cheap relative to its peers.
Distribution profile is weakest of the group
| MLP | 2015 Q1-Q3 Distribution Coverage Ratio | 2015 Q1-Q3 Excess DCF (Annualized) | Excess DCF/Revenue (Excess DCF Margin) | 5-Year Projected CAGR Payout Growth |
|---|---|---|---|---|
| Tallgrass Energy Partners | 1.18 | $32.5 million | 6.6% | 20% |
| Phillips 66 Partners | 1.44 | $62.5 million | 20.2% | 30% |
| MPLX | 1.37 | $61.2 million | 10.7% | 25% |
| Shell Midstream Partners | 1.40 | $42.4 million | 17.9% | 26.2% |
| Valero Energy Partners | 1.96 | $71.3 million | 36% | 30.4% |
Sources: Earnings releases, 10-Qs, 10-Ks, Morningstar, management guidance.
Not only does Tallgrass Energy Partners have the lowest expected distribution growth rate, but its distribution coverage ratio, the best metric for measuring long-term payout sustainability, is by far the weakest.
What's more, management's guidance for full year 2015 DCR is only 1.05-1.1. This means that management is choosing a less conservative, short-term-focused distribution growth strategy. Leaving precious little cash to internally fund future growth.
Strong liquidity, but long-term growth prospects are limited compared with peers
| MLP | Debt/EBITDA (Leverage Ratio) | EBITDA/Interest Ratio | WACC | ROIC |
|---|---|---|---|---|
| Tallgrass Energy Partners | 2.9 | 18.4 | 4.68% | 8.46% |
| Phillips 66 Partners | 5.1 | 7.9 | 13.03% | 19.3% |
| MPLX | 3.1 | 14.3 | 9.63% | 18.86% |
| Shell Midstream Partners | 2.8 | 68.2 | NA | 46.19% |
| Valero Energy Partners | 1.0 | 39.3 | NA | 25.1% |
Sources: Morningstar, GuruFocus.
While Tallgrass Energy Partners has very low debt costs (thanks in part to its low leverage ratio) and the lowest weighted average cost of capital of this group, its overall profitability is also the lowest. In addition, its low excess cash flow makes it almost completely dependent on external debt and equity markets for growth capital, a potentially dangerous policy in today's market conditions.
Granted, thus far Tallgrass Energy Partners seems popular with creditors, having just announced an increase in its revolving credit facility from $850 million to $1.5 billion. It immediately used this new credit to purchase an additional 31.3% stake in the Pony Express Pipeline from its sponsor, privately held Tallgrass Development. At a total cost of $744 million in cash and new units, it means that its credit line has only $272 million remaining.
Which brings me to the main long-term growth problem for Tallgrass Energy Partners, especially compared with the others. Tallgrass Development has only two remaining assets to drop down to its MLP. When combined with potential organic growth projects, this might provide another one to two years of strong distribution growth. After that, however, there's not much in the pipe to fund further payout growth.
Compare this with the others. All four have large general partners with billions in existing assets and new projects that cold be dropped down to the partnership level. MPLX, for example, has a growth backlog of $33 billion.
Source: MPLX investor presentation.
Bottom line
Over the next one to two years, I expect Tallgrass Energy Partners to continue growing at a healthy pace because of its existing sponsor's dropdown pipeline and backlog of organic expansion projects, as well as strong access to growth capital. However, given management's aggressive payout growth policy that results in very little excess DCF, as well as the far smaller long-term investment potential relative to its peers, it's probably better for income investors to consider Phillips 66 Partners, MPLX, and Shell Midstream Partners as better dividend growth prospects over the long haul.
