Holly Energy Partners, L.P. (HEP +0.00%) has a roughly 7.3% distribution yield. That's higher than that of many of its peers, including industry giant Enterprise Products Partners L.P. (EPD 0.72%), which has a 6.4% yield. However, these two midstream oil and gas partnerships operate on a vastly different scale, which has notable implications for the future. But they both have similarly impressive distribution histories. Here's what you need to know if you're on the hunt for a high-yield partnership.
Size matters
Holly Energy Partners has a market cap of around $2.2 billion. That's a tiny fraction of Enterprise's $56 billion market cap. This is a big deal in a couple of ways. For example, Enterprise is way more diversified than Holly Energy. It's also capable of taking on growth projects and acquisitions that Holly could never consider. In fact, for conservative investors, Enterprise is one of the best income options in the midstream partnership space.
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That said, Holly's smaller size means it can grow its business more easily because small deals will have a bigger impact on the top and bottom lines. Enterprise's size can actually be something of a handicap because it needs huge levels of investment to move the needle. It has around $9 billion in spending on tap right now, but it can be hard to find investment opportunities on that scale. Holly Energy Partners' most recent deal was the $250 million acquisition of interests in two pipelines, leaving it as the sole owner of each. It was a good deal for Holly, but would have been a rounding error for Enterprise.
One of the notable things backing Holly Energy Partners' growth has been its relationship with its general partner, independent refiner HollyFrontier (HFC +0.00%). The general partner has been selling midstream assets, or dropping them down, to Holly Energy on a regular basis. This allows Holly Energy to grow its business and increase its distribution, and, at the same time, allows HollyFrontier to maintain control of the assets because it is, effectively, managing HollyFrontier.
That said, incentive payments to HollyFrontier based on distribution growth have increased Holly Energy's cost of capital relative to a partnership like Enterprise, which has internalized its general partner. This is an issue to watch, but Holly Energy is aware of the headwind and is examining ways to deal with the issue, which may include buying back the incentive distribution rights now owned by HollyFrontier.
So, Holly Energy Partners' small size is an important issue. There's more risk in some ways, but it's not necessarily all bad when you take a closer look. Being a tiny midstream player relative to giants like Enterprise opens up opportunities for continued expansion via small acquisitions with which the giants of the industry wouldn't bother. And it helps to have a strong parent like HollyFrontier.
Distribution growth
Both partnerships have long histories of rewarding investors with distribution increases. Enterprise's record of 20 consecutive years is longer than Holly's 14 years (including 2017). It's pretty clear that Enterprise has the better record. Before you give Enterprise the nod here, though, there's another way to look at these streaks.
Within Enterprise's annual streak is a run of 52 consecutive quarterly increases. Holly Energy, meanwhile, has increased its distribution for 51 consecutive quarters. While Holly Energy is six years from Enterprise's annual streak, it's just one quarter from Enterprise's quarterly run. Perhaps more notable, though, is the fact that Holly has increased its distribution every single quarter since becoming public in mid-2004. Enterprise can't make a similar claim.
An opportunity to jump aboard
When you dig a little deeper, Holly Energy's distribution history is every bit as impressive as the one Enterprise has built. And their distribution growth over the past decade has been roughly similar on an annualized basis, with each growing the distribution at around twice the historical rate of inflation growth. So, why not jump on the higher yield?
HEP Financial Debt to EBITDA (TTM) data by YCharts.
Size and diversification are two good reasons if you're a conservative investor. But there's another one that's more prominent today: debt. Holly Energy's debt load has increased materially over the last year or so as it's made growth-minded acquisitions. However, despite the uptick, Holly's debt-to-EBITDA ratio is still lower than Enterprise's. So, this may not be as big of an issue as some investors fear.
If you're looking for a high-yielding partnership, don't dismiss Holly Energy because of its tiny size. It has an almost unbelievable history of distribution growth when you compare it to industry heavyweights like Enterprise. There are clearly important differences between tiny Holly and giant Enterprise, but higher-yielding Holly is definitely worth a closer look if you can stomach a little risk.
