Looking for a big income stream? A huge income torrent is what you'll get instead from these three high-yield master limited partnerships (MLPs).
Better yet, those yields have withstood the test of time -- and in some cases, some pretty rough industry conditions -- but have rewarded investors, quarter in and quarter out. And the companies have also maintained a reasonable valuation along the way. Here's the case for buying Holly Energy Partners (HEP), Buckeye Partners (BPL), and Energy Transfer Partners (ETP).
MLPs pay big distributions to unitholders, and they can be great buys for income-focused investors. Image source: Getty Images.
New structure, same value
The first thing you should know about MLPs is that they are required to pay out all their earnings as distributions to their partners, in exchange for paying no corporate taxes. That's why their yields tend to be sky-high. But even in the universe of MLPs, these three companies have high yields. The lowest yield on the list, that of Holly Energy Partners, is currently 8.5%!
Like the other two companies on this list, Holly is an energy infrastructure MLP, meaning it owns and operates a huge network of pipelines and storage facilities, and a few refining units as well. Business has been good, with revenue up 13% in 2017. To ensure that the company could continue to outperform, management recently reorganized its ownership structure to address perceived shortcomings.
As CEO George Damiris put it, "Eliminating the general partner's IDRs [incentive distribution rights] and the economic GP [general partner] interest will strongly enhance Holly Energy's ability to pursue growth opportunities and manage its business over the long term by decreasing its cost of capital."
One result of the reorganization is that Holly will need to pursue growth through acquisition. That could lead to slower growth than the company has seen in the past, because rising oil prices and increasing valuations have reduced the amount of attractive potential acquisition targets. Still, Holly recently announced its 53rd consecutive quarterly distribution increase, and projected an annual distribution growth rate of 4% for 2018, so investors shouldn't be too worried.
Holly itself remains attractively valued with a current P/E of 14.3, well below industry average. It's worth mentioning, though, that in a high-depreciation business like energy infrastructure, valuation metrics that strip out depreciation -- such as EV (enterprise value) to EBITDA -- are usually a better barometer of value. Good thing Holly's EV-to-EBITDA is also low, at 14.2.
All told, Holly Energy Partners looks like a solid investment for income investors.
Great yield, slim coverage
If Holly's distribution yield and valuation look good, Buckeye Partners' look even better, with an even higher current yield of 11% and lower valuation metrics (lower is better) of a 13.8 P/E ratio and a 12.1 EV-to-EBITDA ratio.
Houston-based Buckeye Partners doesn't get as much coverage as Holly, even though it's more than twice as large by market cap. However, the company's distribution coverage is currently nowhere near as robust as Holly's. Most recently, in the fourth quarter of 2017, Buckeye had distribution coverage of just 1.01 times -- about as slim a margin as you could get!
But the company has 22 consecutive years of dividend increases under its belt, and CEO Clark Smith is adamant that the distribution won't be cut except under very extraordinary circumstances. Here's what he said about that on the most recent earnings call:
Looking forward, during 2018, there may be periods where our distribution coverage falls below one times. However, based on our longer-term outlook, a temporary shortfall in coverage will not affect our distribution policy. Our management team and board views a distribution reduction as an optional last resort. While decisions on distribution policy are made on a quarterly basis, Buckeye currently has no intention to cut its distribution.
That sounds pretty firm, and the company's double-digit yield and unitholder-friendly history should help to convince investors that the company is still a rock-solid investment.
Huge yield, moderate risk
It may surprise investors that a large company with a well-established dividend yield that's trading at an attractive valuation may have some risk attached to it. But that's the case with the third company on the list, Energy Transfer Partners. The partnership has one of the highest yields in the industry at a massive 11.8%. Its P/E is very low at 10.3, and its EV-to-EBITDA is only slightly higher at 12.9. That doesn't sound very risky.
But those numbers don't tell the whole story. One reason Energy Transfer's valuation is so low is that its investors were concerned about its finances. The partnership's balance sheet is awash in debt, and it was only managing to cover its dividend thanks to some special help from its parent Energy Transfer Equity.
When the company announced Q4 2017 earnings, though, it surprised investors with a coverage ratio of 1.3 times, which -- even factoring in Energy Transfer Equity's help -- was a comfortable margin. The company also made some savvy moves to pay down more-expensive debt through asset sales and taking on some less-expensive debt. In other words, although the risk of a distribution cut still exists, it seems more remote than it did last year.
Investors should also remember that, with an 11.8% yield, even if the distribution were cut in half, Energy Transfer Partners would still yield more than many of its peers.
Investor takeaway
For investors looking for big yields at attractive valuations, energy MLPs are an excellent option. However, be aware that there are certain tax implications of owning an MLP that can make filing your taxes more difficult, so they're certainly not for everyone.
But for those who are still interested, Holly Energy Partners, Buckeye Partners, and Energy Transfer Partners currently offer winning combinations of high yields, attractive valuations, and upbeat outlooks.
