3 MLPs With Rock-Solid Distributions

Master limited partnerships have been luring investors with their high yields and reliable distributions for years now. That said, it's easy enough to get caught up in the yield and forget how important a reliable distribution really is. Today, we're investigating distribution reliability with some of our favorite petroleum transportation MLPs: Kinder Morgan Energy Partners (NYSE: KMP), Magellan Midstream Partners (MMP), Holly Energy Partners (HEP), and Plains All American Pipeline (PAA 0.93%).

Can you cover your payout?
To get a sense of an MLP's ability to make its distributions every quarter, we want to take a look at its distribution coverage ratio, which is simply its distributable cash flow divided by the total amount of distributions it paid out. Let's take a look at the third-quarter data for our partnerships.

Source: Company releases. Dollar figures in millions.

It's no accident that this is a great-looking group. Petroleum transportation MLPs have very little exposure to commodity prices, which makes their revenue incredibly predictable.

Kinder Morgan is the biggest MLP in the bunch, and management declared that while its distribution wouldn't be covered in the second or third quarters, as you see here, it would clear 1.0 times payouts for the full-year ending December 31. That's all well and good, but it leaves little flexibility if something -- say a pipeline leak or an unplanned outage on the customer's end -- goes wrong. Regardless, Kinder Morgan plans to grow its distribution by 7% next year, and investors may care more about hitting or missing that target than achieving distribution coverage.

Magellan Midstream, Plains All American, and Holly Energy are sitting pretty with their coverage right where it needs to be. The ratings agencies care deeply about this ratio, but they don't award bonus points for "extra" coverage beyond what they deem is acceptable for a petroleum transportation MLP. In the case of Standard & Poor's, for example, a pipeline MLP need only maintain coverage in the range of 1.0 to 1.1 times payouts. There may be a logical explanation on an individual MLP basis to maintain something higher, but it is not necessary in the eyes of the agency.

Bottom line
The distribution coverage ratio is not the only metric that should be taken into account when evaluating possible investment opportunities. It is important, though, and should be an integral part of any investment thesis when it comes to master limited partnerships.