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Why Holly Energy Partners, L.P. Shareholders Have Nothing to Worry About

By Reuben Gregg Brewer – Jun 27, 2017 at 11:13AM

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Holly Energy Partners has a lot of debt on the balance sheet, but it's not that big a deal.

Holly Energy Partners, L.P. (HEP -1.81%) is a distribution machine, spitting out most of its cash to unitholders (like most partnerships). However, that means that growth has to be funded in other ways, like by issuing new units or taking on additional debt. An increasingly heavy debt load at Holly has some investors worried. That's not unreasonable, but here's why there's nothing to worry about.

The debt trend

At the end of 2013, long-term debt at Holly Energy Partners stood at a touch under $807 million. That debt load increased each year through 2016 when by December it was a little more than $1.2 billion. So Holly Energy's debt increased by nearly 50%in three years. That's a trend to which investors should be paying very close attention.

A man working on a pipeline

Image source: Getty Images.

Over the same span, the partnership's interest expense went from $47 million a year to $52.6 million. That's not as large an increase, but like the level of debt, it's a trend that needs to be monitored. Frankly, it's reasonable that investors would be worried about Holly Energy's debt trends.  

For comparison, Holly Energy's long-term debt made up over 70% of its capital structure at the end of 2016. Enterprise Products Partners (EPD), which many consider one of the best-run midstream partnerships, ended 2016 with long-term debt at roughly 50% of its capital structure. Looking at things a different way, interest expense ate up around 13% of Holly Energy's revenue in 2016 but just about 4% of Enterprise's revenue. Clearly, there's a reason to be concerned.

Carrying the weight

But don't get too caught up in the debt because Holly Energy looks like it can handle it. For starters, the company's business is 100% fee-based, with around 80% of its revenues under long-term contracts. That means it has highly stable recurring income, the type of business model that can handle a relatively high debt load.

And you shouldn't forget that the debt was taken on for a good reason: to grow the business. For example, revenues grew roughly 30% between 2013 and 2014. That's a direct result of the new assets the partnership acquired with the debt it took on.

HEP Financial Debt to EBITDA (TTM) Chart

HEP Financial Debt to EBITDA (TTM). Data by YCharts.

Then there's the fact that Holly is aware of the debt issue and is doing something about it. For example, it issued additional units to help shore up its balance sheet in the first quarter. But to give you a guidepost, based on the partnership's business model, management has stated it's comfortable with a debt-to-EBITDA ratio of four. 

Holly Energy's debt to EBITDA is over four today and might remain above target for a bit while the partnership works down its debt. But that metric has been above that target before and then worked lower over time. It's reasonable to expect the same trend this time around, especially since management is clearly on top of the situation.

Part of the model

In the end, taking on debt to fund acquisitions is just part of Holly Energy Partners' business model. Once those assets join the family, management starts to reduce leverage toward targeted levels again. It's happened before and it's going to happen again. There's no question that a heavy debt load is concerning and something you need to watch closely. But it's no reason to jump ship. For Holly Energy, it's just par for the course.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.

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