Shares of Holly Energy Partners, L.P. (NYSE:HEP) advanced 1% in 2017. That may not sound like much until you compare it to the Alerian MLP ETF, which tracks an index of energy infrastructure MLPs (master limited partnerships), and which fell roughly 14% this year. In relative terms, Holly Energy was a standout performer. But stock market performance isn't what you should focus on when you think about the company's 2017 -- there was a much more important development that will have a major, long-term impact.
Good: By the numbers
Holly's unit price beating the MLP index by roughly 15 percentage points is clearly a notable development -- but it didn't happen in a vacuum. For one thing, Holly bought some newly built refinery assets from parent HollyFrontier (NYSE:HFC) in late 2016. That investment more than tripled the revenue Holly Energy generated in the refinery business through the first nine months of 2017 compared to the same period last year.
The terminal business, meanwhile, saw a 4% revenue increase. That was a solid, though not spectacular, showing. However, when combined with the refinery advance, it was more than enough to offset some weakness in Holly's pipeline business (down about 7.5%). Overall, the top line increased by 12%, year over year, though the first three quarters. Distributable cash flow increased 10%.
Which is why Holly Energy kept increasing its distribution every quarter throughout the year. Its streak is now up to 52 consecutive quarters. That's a hike in every single quarter since the partnership's IPO.
So there were some really good things going on in 2017 at Holly Energy. And while its coverage ratio was relatively weak, partly a result of new units being issued (more on this in a second), solid results suggest that covering the distribution is not going to be a big deal over the long term.
A more memorable change
When you look back on 2017, all of those numbers above will probably get lost in the haze. The bigger change, and the one that will have a larger long-term impact, was structural. In October, Holly Energy bought the long-term general partner incentive distribution rights from parent HollyFrontier.
Holly Energy is effectively run by HollyFrontier, which gets paid a management fee for its efforts. HollyFrontier owns a large number of partner units, too, so it gets distributions as well. But it also receives incentive payments for increasing Holly Energy's distribution over time. That's a normal structure in the partnership space, but it increases Holly Energy's cost of capital over time. By removing the incentive distribution rights, Holly Energy believes it will cut its equity financing costs from 11% to 7.5%.
Such a drop would materially lower the hurdle for Holly Energy when it looks at new investments. And it would make growth from this point forward that much easier to achieve. To be fair, Holly Energy had to issue roughly 37.3 million units to buy back the incentive distribution rights. That's a big part of the reason the coverage ratio was weak in the third quarter. But with a notably lower cost of capital going forward, it should easily be able to grow its way out of that dilemma while continuing to up the disbursement over time.
2017: A foundation for growth
Overall, Holly Energy's business had a good year, financially. The units did relatively well, too. But the really memorable event from 2017 will be the October decision to buy the incentive distribution rights from parent HollyFrontier. While that change is causing some near-term headwinds for distribution coverage, it should help spur the partnership's growth for years to come.