While Sunoco LP (SUN 5.61%) currently yields a jaw-dropping 10.9%, that payout is on shaky ground. Not only does the company distribute nearly all its available cash flow to unitholders, since its coverage ratio has averaged 1.03 times this year, but it has a pile of debt on its balance sheet, evidenced by a concerning leverage ratio that was 5.97 times at the end of last quarter. The company, however, is in the process of shoring up its financial situation by selling its convenience-store business in a $3.3 billion deal to 7-Eleven.
That said, even with that looming catalyst on the horizon, there are better options out there for income-seeking investors. Three better buys, in my opinion, are Phillips 66 Partners (PSXP), MPLX (MPLX 0.83%), and Summit Midstream Partners (SMLP 0.18%).
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A massive margin of safety with ample upside
While Phillips 66 Partners currently yields about half what Sunoco LP does at 5.3%, that payout is on much safer ground. First of all, 100% of Phillips 66 Partners' earnings come from fee-based contracts, which enables the company to generate stable cash flow. Contrast that with Sunoco LP, which, after selling its retail assets, will still only get 87% of its earnings from stable sources.
Second, Phillips 66 Partners maintains a much more conservative distribution-coverage ratio that has averaged 1.33 times this year. Finally, it has an investment-grade credit rating backed by a low 3.5 times leverage ratio.
Not only is Phillips 66 Partners' current payout on rock-solid ground, but it will likely continue growing at a healthy clip. In fact, the company plans to increase the payout by a 30% compound annual rate through the end of next year via a combination of drop-down transactions from its parent company and organic growth projects. Given the visibility of what Phillips 66 Partners has in the pipeline, it's very likely that it can achieve that ambitious distribution-growth goal.
A rock-solid payout with visible growth on the horizon
MPLX shares many similarities with Phillips 66 Partners. For example, fee-based assets also supply the bulk of its income, as 95% will come from stable sources this year. Meanwhile, it has a solid balance sheet given its low 3.8 times leverage ratio and healthy distribution coverage that has averaged 1.25 times so far this year. Those three factors provide excellent support for the company's generous 6.8% distribution.
Meanwhile, MPLX is in the midst of working through several strategic actions with its parent to enhance value. These include the planned drop down of assets that generate $1.4 billion of annual earnings by year-end and the elimination of its high-cost incentive-distribution rights. MPLX believes that these actions will simplify the company's structure, lower its capital costs, and improve the visibility into future growth. Further, the company has a slew of organic growth projects underway that support its ability to increase the distribution by 12% to 15% this year and at a double-digit rate in 2018.
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A higher yield, but with a bit more risk
Summit Midstream Partners offers the highest current yield of the group, at 11.8%. That said, unlike Sunoco LP, it can afford that payout since it has better financial metrics, given that its coverage ratio has averaged 1.15 times this year, while leverage is currently 4.35 times. Further, 98% of its earnings come from stable fee-based contracts.
Meanwhile, cash flow should increase over the coming years due to the growth projects the company has coming down the pipeline. The most recent is a $110 million investment in a gathering and processing project for an ExxonMobil (XOM -0.05%) subsidiary in the Permian Basin. The initial phase of that project should enter service in the second quarter of next year, and it has significant expansion potential as Exxon and others increase production in this fast-growing region. In fact, Summit estimates that the region will need $5 billion of infrastructure development over the next several years to support producers, and it's already evaluating more than $500 million of opportunities.
That said, one reason its payout is in the double digits is that the company owes its parent a deferred payment for a drop-down transaction they undertook in 2016. Summit must make this payment by the end of 2020, which it currently estimates will be around $800 million. The unknown surrounding how the company will finance that obligation is weighing on units, though it still has plenty of time and options to opportunistically raise the money, while maintaining conservative coverage and leverage metrics.
Better income options for investors
While Sunoco LP is working to turn around its financial situation and put its payout back on solid ground, it's still possible that the company might have to reduce the distribution. Given that uncertainty, investors are better off with either Phillips 66 Partners, MPLX, or Summit Midstream Partners, since they have lower-risk business models and stronger financial metrics. This makes it likely that their distributions will head higher in the future.
