Investors Beware: Don't Buy the Next Boardwalk Pipeline Partners, LP

Boardwalk Pipeline Partners (BWP) got crushed Monday, when management announced that it will cut the distribution 81% to a mere $0.10 per unit. It was a spectacular downfall for the master limited partnership, but it yields an important lesson for investors considering MLPs: Don't overthink these investments.

We live in a world awash with data, but when it comes to buying an MLP, investors don't need to work very hard to separate the wheat from the chaff. There are two numbers you want to consider: the distribution coverage ratio, and the number of consecutive quarters with a distribution increase. Today we'll examine this idea using Enterprise Products Partners (EPD 0.25%), Sunoco Logistics Partners (NYSE: SXL), Enbridge Energy Partners (EEP), and of course, Boardwalk Pipeline Partners.

Consistency matters
The number of consecutive quarters with a distribution increase is usually reported every quarter; if not, you can always check the dividend history link at Yahoo! Finance or the investor relations page of an individual MLP.

Let's look at distribution growth for our four MLPs over the past five years:

BWP Dividend data by YCharts

Even before its pop in 2012, Sunoco Logistics grew its distribution reliably. Enterprise, too, displays a regular commitment to growth. In fact, these two MLPs rank among the top four of all MLPs for consecutive quarterly distribution increases. Enterprise is first, Sunoco Logistics is third, and both have records that stretch more than eight years.

It's quite a different story when you look at Boardwalk and Enbridge Energy Partners. Enbridge has kept its distribution flat for seven straight quarters, and before yesterday's cut, Boardwalk's quarterly payout had been flat for nine.

Your distribution is showing
Which brings us to our next set of data: distribution coverage. It's a simple calculation that indicates whether the MLP is generating enough cash to cover the distributions it pays out. To calculate the metric, locate your MLP's distributable cash flow and divide it by the distributions that will be paid for the corresponding quarter. If the resulting number is greater than 1.0, your MLP's distribution is safe. If it isn't, management has some explaining to do.

Back in November, I included Boardwalk in a simple coverage ratio exercise, expressing concern that the MLP was holding its distribution flat yet still couldn't cover its payments.

That is not a winning combination, and Enbridge actually has the same issue. Look at its coverage ratio performance for the past three quarters (the partnership reports Q4 results on Wednesday):

Source: MLPData.com.

Again we have the pattern of an MLP that holds its distribution flat and cannot cover those payouts. Does this mean Enbridge is going to implode when it reports earnings tomorrow? Not necessarily, but why buy something like that when you could buy an MLP like Enterprise or Sunoco?

Let's take a look at their coverage ratio numbers for Enterprise:

Source: MLPData.com

And for Sunoco Logistics:

Source: MLPData.com

These are two MLPs that not only increase their payouts quarter after quarter, but also cover those increases with the same consistency.

Ultimately, what do these two factors indicate to investors? They show us management's ability to grow a solid, sound business. Yes, once you've narrowed down the field to the most reliable players, there are certainly other metrics and business factors to consider before buying. But don't overthink this. If an MLP doesn't pass these first two tests, it's probably not worth the risk in the long run.