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If You Think This Energy Company's 3.5% Dividend Yield Is Attractive, You Should Check Out Its MLP

By Matthew DiLallo – Sep 15, 2019 at 9:15AM

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At 6.1%, this midstream company’s payout should appeal to yield-seeking investors.

Phillips 66 (PSX 2.78%) has been an excellent dividend stock over the years. Since its formation in 2012, the refining giant has increased its payout nine times, growing it at an impressive 25% compound annual rate. Because of that, the company now yields an above-average 3.5%.

However, as attractive as that payout might be, Phillips 66 offers investors an even better income option in its master limited partnership (MLP) Phillips 66 Partners (PSXP). Here's why yield-seeking investors won't want to overlook that company.

A roll of cash next to a calculator and a sticky note with the word dividends.

Image source: Getty Images.

An exceptional income stock in its own right

Phillips 66 formed its MLP in 2013 to drive its midstream growth. The refiner initially did that by dropping down its midstream assets to that entity. Those transactions provided Phillips 66 with cash to invest in expansion projects and repurchase its stock. Meanwhile, the steady diet of acquisitions gave Phillips 66 Partners the fuel to grow shareholder distributions. Overall, the company has been able to increase its payout for 23 straight quarters. That's helped grow the MLP's yield up to its current level of 6.1%.

That above-average yield is on as firm a foundation as investors will find in the midstream space. For starters, Phillips 66 Partners generates very stable and predictable cash flow backed by long-term, fee-based contracts, which currently supply all its earnings. Meanwhile, the company generates enough cash to cover its payout by a comfortable 1.44 times, which is well above the 1.2 comfort level of most MLPs. On top of that, the company's leverage ratio was 2.8 times debt-to-EBITDA at the end of the second quarter, which is comfortably below the 4.0 target of most rivals. Phillips 66 Partners' payout is thus on a very sustainable footing.

Flipping the switch on a new growth engine

As noted, one of the main factors fueling Phillips 66 Partners' distribution growth over the years has been the acquisition of midstream assets from Phillips 66. While the refining giant still owns some infrastructure, it has sold the bulk of those assets to its MLP. As a result, Phillips 66 Partners has had to switch over to a new growth engine: investing in organic expansion projects.

The company currently has several under construction. The biggest is the Gray Oak pipeline that will transport oil from the Permian Basin to the Gulf Coast, which it expects to finish by the end of this year. It's also investing in a new export terminal in Texas and expanding two pipelines as well as a storage facility. These projects will give Phillips 66 Partners the fuel to continue increasing its distribution to investors for the next several years.

Meanwhile, with a top-notch balance sheet, the company has the financial flexibility to make acquisitions from both Phillips 66 and third parties. While Phillips 66 has already sold most of its midstream assets to its MLP, it's building more including the Red Oak and Liberty pipelines. It could eventually sell those assets and others it owns to its MLP. Meanwhile, Phillips 66 Partners has the scale and financial strength to make outside acquisitions. So the company has plenty of ways to supplement its organic growth projects if needed.

An excellent option for yield-seekers

While Phillips 66 has been a great dividend stock over the years, its MLP is an even better option for income-focused investors. Not only does it pay a higher yield, but it also should have no problem continuing to increase its payout, given its growth prospects. That makes it an ideal option for investors seeking income.

Matthew DiLallo owns shares of Phillips 66. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Phillips 66 Stock Quote
Phillips 66
PSX
$76.22 (2.78%) $2.06
Phillips 66 Partners LP Stock Quote
Phillips 66 Partners LP
PSXP

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