The business structure of a master limited partnership forces it to pay out most of the cash it generates to its investors. As a result, MLPs must issue debt and equity to fund growth. Where too much equity will disappoint investors, too much debt has sunk many a ship on Wall Street.
To tell whether an MLP's debt is serviceable, investors want to look at the debt-to-adjusted EBITDA ratio. Today we're doing just that with four popular MLPs: Energy Transfer Partners (NYSE:ETP), Enterprise Products Partners (NYSE:EPD), Kinder Morgan Energy Partners (UNKNOWN:KMP.DL), and Sunoco Logistics (NYSE:SXL).
Calculating debt-to-adjusted EBITDA is just a simple division equation. Take an MLP's most recent debt figure and divide it by the last four quarters of adjusted EBITDA. Almost every MLP now uses the adjusted EBITDA metric, so both numbers are relatively easy to track down in a quarterly or annual filing.
Again, this metric will give us some indication of a partnership's ability to pay its debts. The ratio will make clear if earnings are too low or debt is too high. And, because it is a ratio, it allows us to compare MLPs of all shapes and sizes.
On top of that, credit agencies incorporate the metric into their credit ratings. Typically, Standard & Poor's likes to see a ratio no higher than 4.0 to 4.5 times debt-to-adjusted EBITDA for investment-grade master limited partnerships. That rating will tie in directly to the interest rates on a partnership's debt, increasing the importance of a healthy ratio.
Let's take a look at how the metric shapes up right now at our four MLPs:
You can see that right now all of our MLPs are OK by the ratings agencies, but that was not always the case, as both Enterprise Products Partners and Energy Transfer Partners have posted a ratio higher than 4.5 times at some point in their recent histories.
Management at Energy Transfer Partners has said the partnership is targeting 4.0 to 4.25 times debt-to-adjusted EBITDA going forward. Its ratio is now at 4.3 times, so that certainly seems feasible.
Sunoco Logistics is looking great at 2.5 times debt-to-adjusted EBITDA. In fact, given the ratios sported by its peers, one might argue the reverse of too much debt is true here. Is its ratio too low? Shouldn't Sunoco take on more debt to spur growth? Given that the partnership has more than doubled its distribution over the time period used in the chart above, and that its unit price has appreciated close to 400% in that time, we might be wise to just leave well enough alone here.
Look at the figures
If you're worried that your MLP has bitten off more than it can chew, reviewing debt and adjusted EBITDA figures from SEC filings is a good way to find out. Putting those numbers in context to what the rest of the industry is doing, and what ratings agencies deem appropriate, is also important.
Fool contributor Aimee Duffy has no position in any stocks mentioned. The Motley Fool recommends Enterprise Products Partners L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.