Holly Energy Partners, L.P. (HEP) has a robust 9.3% distribution yield. Andeavor Logistics LP's (ANDX) yield is even higher at around 9.6%. If you are looking to boost the income you generate from your portfolio, both of these high-yielding midstream limited partnerships might look enticing. But you need to step back and look at the big picture before you buy either of them. The decision between these two high-yield partnerships, ultimately, boils down to your ability to handle uncertainty.
First, some similarities
Both of these partnerships generate income by providing the vital pipes and other assets that help to get oil and natural gas from where they are drilled to where they are processed and eventually used. Roughly 95% of Andeavor Logistics' cash flow is backed by fees for the use of its assets. That figure is nearly 100% at Holly Energy Partners. A focus on fees, effectively tolls for the use of their assets, reduces the risk of commodity price fluctuations and means that both of these partnerships have fairly stable and recurring cash flows underpinning their high yields.
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In addition, Holly and Andeavor Logistics also have supportive parent companies. Holly's general partner, and largest unitholder, is HollyFrontier Corporation (HFC). Andeavor Logistics' general partner, and largest unitholder, is Andeavor (ANDV). These companies are both refiners with sizable businesses, with $12 billion and $20 billion market caps, respectively. HollyFrontier and Andeavor have supported their controlled partnerships' growth via regular asset sales, called drop-downs in the industry, that have helped to steadily boost revenues and distributions over time.
The supportive nature of the general partners includes a lack of incentive distribution rights (IDRs), a common feature in the midstream space that rewards general partners for increasing a partnership's distributions. IDRs can be a headwind to growth because they increase a partnership's cost of capital as distributions are increased. HollyFrontier agreed to eliminate IDRs in 2017, a move that Holly Energy estimated would lower its costs of equity by as much as 30%. The fact that neither of these partnerships is obliged to pay IDRs to their general partners is a material benefit for unitholders.
And now for some big differences
Reducing Holly Energy's cost of capital is actually rather important today because HollyFrontier no longer has any material assets to sell to its controlled partnership. That means that Holly is shifting into a new phase of growth, one that will be driven by ground-up construction, acquisitions from nonaffiliated companies, and third-party purchases made in conjunction with parent HollyFrontier. This means that Holly Energy's growth is going to be far less certain in the future than it was in the past.
The partnership's historical success and the supportive nature of parent HollyFrontier, however, should be enough for most investors to give Holly Energy the benefit of the doubt for now. That history, for reference, includes over 50 consecutive quarterly dividend increases. And with roughly 80% of its 2018 capital budget earmarked for expansion projects, it's reasonable to expect the partnership to keep growing and to keep increasing its distribution as it works to adjust to a new life stage. That said, investors should probably expect distribution growth to slow from the partnership's mid-single-digit historical rate over the near term as it works through this transition period.
Andeavor Logistics isn't exactly facing any direct changes today, but parent Andeavor is set to be acquired by Marathon Petroleum, an even larger refiner with a $30 billion market cap. So Andeavor Logistics' general partner is changing. Complicating this fact even further, Marathon Petroleum is the general partner of its own limited partnership, MPLX LP. With the Marathon/Andeavor deal pending, investors probably shouldn't expect any material drop-downs between Andeavor and Andeavor Logistics.
But, at this point, Marathon isn't planning to make any changes to Andeavor Logistics or MPLX. Prior to the Marathon deal, Andeavor Logistics expected drop-downs to make up the lion's share of its roughly $1 billion annual capital budget between 2018 and 2020. Those drop-downs may be paused for now, but are likely to resume once Andeavor is bought by Marathon. Andeavor Logistics, with projected EBITDA of around $1.25 billion in 2018, estimates that Andeavor owns partnership-eligible assets that could add another $600 million to its EBITDA. So, assuming things don't change following the merger of Marathon and Andeavor, there is a robust pipeline of drop-downs.
Notably, there's little overlap in the asset bases of Andeavor Logistics and MPLX, so there shouldn't be too much internal competition for assets after the acquisition closes. However, longer term it might make sense for Marathon to merge the two entities. That adds notable uncertainty to the mix since MPLX's 7.2% distribution yield is lower, suggesting it would be the surviving entity in a merger of the two partnerships. Distribution yield is part of the "cost" of issuing new units, so a lower distribution yield would mean a lower cost of capital.
Thus, in the long run, Andeavor Logistics unitholders could see a distribution cut if Marathon decided to combine its two controlled partnerships. Worse, Andeavor Logistics' distribution growth has been higher than that of MPLX, so investors could see potentially slower distribution growth going forward, too. But, unlike Holly Energy, Andeavor Logistics (alone or combined with MPLX) looks like it has material opportunities for growth via drop-downs from a supportive parent -- which means growth, even if it is slower than in the past, is far more certain.
A tough call, but...
If you are looking at Holly Energy and Andeavor Logistics, there are a lot of moving parts right now. Holly isn't a bad partnership by any stretch of the imagination. But it is transitioning to a new phase of growth, and it's not certain what that will look like for investors just yet because its general partner hasn't got anything left to drop down to the partnership.
Andeavor Logistics, meanwhile, is likely to see some changes as parent Andeavor gets acquired by Marathon Petroleum. They could be big or small; there's no way to tell what's going to happen just yet, and Marathon isn't talking. That means that, of the two partnerships, the future is probably more uncertain at Andeavor Logistics right now. However, because of the still-material asset base available for drop-downs, I would give Andeavor Logistics the nod here for more aggressive investors. It's highly unlikely that Marathon will effectively abandon Andeavor Logistics, and even after a merger with MPLX, the growth opportunity would still be more certain here than at Holly Energy.
