Midstream oil and natural gas partnership Holly Energy Partners (HEP) has shown an incredible commitment to rewarding unitholders. That includes a lofty 8.3% distribution yield right now, but there's so much more to the story than that. Here's a look at this partnership's impressive history of distribution growth and how likely it is that management can keep rewarding unitholders so well.
What Holly Energy does
Holly Energy Partners owns a collection of 100% fee-based assets that help move oil and natural gas from where they are drilled to where they are refined and then on to where they are consumed by end users. It is controlled by general partner HollyFrontier Corp (HFC), a large domestic refiner.
Image source: Getty Images.
This relationship has worked quite well for both parties, with HollyFrontier selling -- or "dropping down," in industry lingo -- fee-based assets to Holly Energy over time to help grow the partnership. Because HollyFrontier controls Holly Energy, it retains control of the midstream assets it sells, gets paid fees for managing them, collects distributions from its ownership stake in the partnership, and, until recently, received incentive payments as Holly Energy's distribution grew over time (more on this in a little bit). All of this is pretty standard practice in the partnership space.
Although you could examine any number of metrics to see just how this has worked out, the partnership's distribution is a great place to start. Holly Energy has increased its distribution every single quarter since coming public in 2004. That's 53 consecutive quarters and counting. The average annualized distribution increase over the past decade was 6%, roughly twice the historical level of inflation growth.
| Metric | 2017 | 2016 | 2015 | 2014 | 2013 | 2012 | 2011 | 2010 | 2009 | 2008 |
|---|---|---|---|---|---|---|---|---|---|---|
| Distribution | $2.505 | $2.32 | $2.1675 | $2.045 | $1.925 | $1.8075 | $1.72 | $1.64 | $1.56 | $1.48 |
| Growth | 8% | 7% | 6% | 6% | 6.5% | 5% | 5% | 5% | 5% | 6% |
Data source: Holly Energy Partners.
For roughly 14 years Holly Energy has provided investors with a pay raise every quarter at a rate that handily outstrips inflation. That's a very impressive record and one that management should be proud of.
A changing relationship
Holly Energy and HollyFrontier recently amended their relationship. Holly Energy bought HollyFrontier's incentive distribution rights. That move required an up-front payment in new units, but will reduce Holly Energy's cost of capital in the future. The partnership estimates that its cost of equity will drop from 11% to around 7.5%, a notable improvement.
The timing of this transaction isn't an accident. After 14 years, HollyFrontier has sold most of what it has to sell to Holly Energy. That means that Holly Energy's future growth will be more reliant on new projects, expansions of existing assets, and external acquisitions than it has in the past. Reducing the cost of capital will make it easier for the partnership to fund that growth.
Holly Energy's relationship with HollyFrontier. Image source: Holly Energy Partners, L.P.
Over the near term, however, there are some growing pains. For example, buying the incentive distribution rights required the issuance of over 37 million new units. That has pushed the partnership's coverage ratio to roughly 1. It is still covering the distribution, but coverage is at the low end of its targeted 1.0 to 1.2 range. The goal is for modest 4% distribution growth in 2018.
In other words, look for Holly Energy's streak of distribution increases to continue. However, don't expect the same level of distribution growth over the near term. Holly Energy needs some time to adjust to the new normal. Once it does, however, distribution growth could tick higher again -- something for which investors should be watching.
Nothing to worry about
At the end of the day, it appears that Holly Energy's impressive history of distribution growth is safely going to continue. Expect a lull in the pace of distribution increases, but that's because of a strategic change that better positions the partnership for the long term. If you are looking for a large and growing distribution, Holly Energy is worth a deep dive today as it prepares itself for the future.
