Change was in the air in 2017 at Holly Energy Partners, L.P. (HEP) and Andeavor Logistics LP (ANDX), formerly known as Tesoro Logistics LP. The ultimate goal at each was preparing for the future; however, only one of these two midstream oil and natural gas partnerships has laid out a clear path for growth, and that gives one of these high yielders a slight edge. Here's what you need to know.
Lowering the cost of growth
Holly Energy Partners is controlled by refiner HollyFrontier (HFC), its general partner. General partners usually get paid management fees for running a limited partnership, distributions from the units it owns, and incentives fees when the partnership's distribution increases. Over the years, that led to numerous growth-oriented assets sales, known as drop-downs, between HollyFrontier and Holly Energy as HollyFrontier looked to maximize growth at its controlled partnership.
Image source: Getty Images.
However, that relationship changed slightly in 2017. Holly Energy bought the incentive distribution rights from HollyFrontier. It's not that the incentives weren't working; Holly Energy has an impressive history of distribution increases, including an increase every quarter since its IPO in 2004. The problem is that the increasing incentives create a headwind to growth because they increase Holly Energy's cost of capital over time. Ultimately, getting rid of this cost is a good move for unitholders even though it costs the partnership money over the short term.
Part of the issue is that most of the drop-downs that could happen between HollyFrontier and Holly Energy have already happened. So, growth from here will be harder to come by. With a roughly $2 billion market cap, it won't take much to move the needle at Holly Energy; however, it still needs to find new growth opportunities. In fact, the partnership hasn't actually spelled out any specific plans for growth over the next couple of years. I believe it will find suitable investments to sustain its growth over time, but that takes something of a leap of faith at this point and will probably include more non-affiliated acquisitions -- something that is harder to predict than a drop-down.
A clear growth path
Andeavor Logistics is controlled by refiner Andeavor (ANDV). Last year was a big one for this pair. Andeavor acquired Western Refining, which left it as the general partner of both Andeavor Logistics and Western Refining Logistics. To simplify things, the general partner had Andeavor Logistics acquire Western Refining Logistics. There was also a name change in there, with both exchanging the Tesoro name for Andeavor.
In addition to all of that, Andeavor Logistics purchased its general partner's incentive distribution rights. So, at this point, both the partnership and its general partner have grown materially. And, like Holly Energy, the partnership also reduced the capital costs it will face as it grows.
Endeavor Logistics has definite plans to support growth over the next few years. Image source: Andeavor Logistics.
Andeavor Logistics, with an $11.5 billion market cap, is a much larger entity than Holly Energy, so it will take larger investments to move the needle. However, Andeavor Logistics is also a younger partnership, having come public in 2011, so there are still assets that can be dropped down from the parent. (Like Holly Energy, Andeavor Logistics has increased its distribution every quarter since its IPO.) And then there were the two acquisitions in 2017 that help to expand the partnership's growth opportunities. Right now, Andeavor Logistics is projecting roughly $1 billion of growth spending each year between 2018 and 2020, with roughly half to come from drop-downs and the rest from internal growth projects and acquisitions. That's a much clearer path to growth than what is being offered by Holly Energy right now.
How full is your glass?
Both Andeavor Logistics and Holly Energy have supportive general partners. And both have worked to lower their costs of capital by buying their incentive distribution rights back. However, they are in slightly different places when it comes to growth.
Holly Energy's smaller size is a net benefit as it looks to expand, but it doesn't appear to have material and definite plans right now. Andeavor Logistics' future is a lot clearer, backed by $1 billion a year in planned spending. If you are a glass-half-full kind of person, then Holly Energy's strong history of growth is probably enough to entice you to buy into its over 8% yield. But if you are a glass-half-empty type, then Andeavor's slightly lower 7.5% yield will be more appealing because it has a clearer growth path ahead. In the end, I think that gives Andeavor a slight edge, here.
