In an earlier article, we saw how the World Cup winning German soccer team was the product of 14 years of patience and fundamental skill development, and used these ideas to examine some quality energy investments for retirement planning. Here, we'll look at master limited partnerships, or MLPs. MLPs require a different set of metrics since they are required by law to pay out most of their profits to investors.
Specifically, we'll look at distribution coverage ratio (DCR), debt/EBITDA ratio, and price to distributable cash flow ratio (price/DCF). Of course, the core business needs a good look, too. Here are three MLPs to consider.
Classic midstream company
Moving resources from point A to point B -- many companies do that. What sets Magellan Midstream Partners (NYSE:MMP) apart is what it moves. Most midstream energy companies move crude oil and natural gas; Magellan mainly moves refined products. Magellan claims to operate the longest refined petroleum products pipeline system in the US. In fact, over 70% of Magellan's business is transporting refined products, with the balance being crude oil and marine terminal storage.
Two business fundamentals makes Magellan attractive. First, over 85% of its business is fee-based, meaning a steady revenue stream with limited exposure to commodity price fluctuations. Second, the company plans organic growth rather than acquisitions. This growth includes expanding its crude oil capacity in the productive Permian Basin and Eagle Ford plays. Additionally, the company is building a condensate splitter at its Corpus Christi facility. This splitter can produce a variety of products, including high-sulfur diesel for export to Latin America.
Augmenting these business advantages are excellent financial metrics. For MLPs, debt is a constant feature since profits are mostly paid out. Typically, a debt/EBITDA ratio of 4.0-4.5 or lower is desirable. For Magellan, the ratio is 3.0. Looking at DCR, a ratio of 1.0 indicates sustainable distributions and Magellan's DCR comes in at 1.1 to 1.4 over the past year -- no problems there. For valuation, look for a price/DCF ratio of 16. Magellan sells at a ratio of 26.9, indicating an expensive MLP. It also indicates a lot of investor confidence, however.
The ultimate "pick and shovel" play?
Hydraulic fracturing needs sand -- lots of it -- and Hi-Crush Partners (NYSE:HCLP) supplies some of the most popular types of sand used in hydraulic fracturing. Beyond just digging sand out of the ground, Hi-Crush transports its sand to some of the most active oil and gas plays in the country.
Hi-Crush offers investors constant growth. Every month it seems the company announces another new or expanding long-term contract to supply sand to yet another customer. The latest new customer is C&J Energy Services. This growth translates into growing distributions, with the latest distribution growing 9.5% over the previous quarter's distribution.
The financial fundamentals look good, too. Hi-Crush boasts a low debt load with a debt/EBITDA of 1.9. The growing distribution is covered by a DCR of 1.0-1.2. Like Magellan, investors have noticed Hi-Crush's strong business basics and are willing to pay a 31.8 price/dcf for the company. The stock has more than doubled over the past year.
Natural gas liquids for home and abroad
Another midstream MLP to consider is Targa Resources Partners (NYSE:NGLS). This company stores, transports and exports crude oil, natural gas, and natural gas liquids such as butane and propane. The main focus of the company is on natural gas and natural gas liquids. One important trend in Targa's business model is the increase in fee-based contracts. In 2010, roughly 25% of Targa's business was fee-based. Today it's closer to 60%, and by the end of the calendar year, Targa aims for 65% fee-based contracts.
Targa has $1 billion in expansion projects coming online in 2014. These projects include increasing processing capacity in the Bakken, Permian Basin, and Barnett shale plays; increasing storage capacity at its Mont Belvieu facility; and increasing export capacity at its Galena Park Marine Terminal. By the end of 2014, Targa's export capacity should grow by 50%. These 2014 projects follow roughly $1 billion worth of growth in 2013.
Regarding financial metrics, Targa holds one advantage over Magellan and Hi-Crush: its price/DCF is only 18.4, making Targa a better value. The other metrics hold up as well: Targa's debt/EBITDA typically runs 3.7 with its latest quarter coming in at 3.0. The DCR is 1.6, indicating not only some buffer for distribution increases, but some cash in the bank to pay for expansion.
Final Foolish thoughts
Fourteen years of teaching young players the fundamentals of the game helped Germany win a World Cup. Paying attention to fundamentals and having a long-term investment horizon can pay well when retirement comes. While all three MLPs here offer attractive returns, Targa's low valuation makes it stand out. The core business, particularly its exports of natural gas liquids, should grow and propel distributions by 7% to 9% a year. This company has room to run and could take your retirement income with it.
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Robert Zimmerman owns stock in Hi-Crush Limited Partnership. The Motley Fool recommends Magellan Midstream Partners. 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.