Is MarkWest Energy Partners a Buy?

Why MarkWest Energy Partners’ extensive investments in the Marcellus and Utica shales should drive stronger distribution growth after 2015.

Arjun Sreekumar
Arjun Sreekumar
Apr 29, 2014 at 1:13PM
Energy, Materials, and Utilities

As U.S. hydrocarbon production continues growing at a rapid clip over the next few years, so will demand for midstream services, including storage, transportation, and processing. MarkWest Energy Partners (UNKNOWN:MWE.DL) finds itself well positioned to capitalize on these expected trends thanks to its leading position in Pennsylvania's Marcellus shale and Ohio's Utica shale, two rapidly growing resource plays.

Over the next couple of years, the partnership will greatly expand its processing and fractionating capacity in these two plays, which should provide a big boost to EBITDA and cash flow and allow for stronger per-unit distribution growth in the years ahead. Let's take a closer look.

Photo Credit: Wikimedia Commons

Leading positions in Marcellus and Utica
MarkWest Energy Partners is a master limited partnership involved in the gathering, processing, fractionation, and transportation of natural gas, natural gas liquids, and crude oil in various U.S. regions, the including Southwest, Gulf Coast, and Northeast.

MarkWest has done a great job in recognizing the massive potential of leading shale plays such as the Marcellus and the Utica. Since 2008, the partnership has invested over $6 billion in the Marcellus and the Utica and is currently the largest processor in both plays -- a major competitive strength given the high and growing demand for processing capacity.

Though the largest portion of MarkWest's operating income has traditionally come from gathering and processing operations in the southwest, the company's Marcellus and Utica shale operations will account for much larger shares of total operating income in the years ahead. This year, the partnership forecasts the Marcellus to account for 47 % of total operating income and the Utica to account for 13%, while the Southwest will account for 31%.

Spending ramp-up to drive growth
Since its IPO, MarkWest has consistently executed on over $9 billion of organic growth projects and acquisitions that have driven 244% distribution growth over the period, or 11.6%  compound annual growth. Going forward, a significant ramp up in capital spending should drive even stronger distribution growth.

This year, the partnership expects to spend between $1.8 billion and $2.3 billion on growth projects, with construction already under way at 19 major processing and fractionation projects. The vast majority of this spending will target expansion projects in the Marcellus and the Utica, with 67 % of the partnership's capital budget set aside for the Marcellus and 26% earmarked for the Utica.

With 10 processing plants in the Marcellus and Utica slated for completion this year, MarkWest expects to more than triple its total processing capacity from 2011 levels to 6 billion cubic feet per day by 2015. Since the company's revenues are based on contracted volumes, this should provide a big boost to EBITDA and distributable cash flow.

As these fee-based projects come online, they will also significantly increase the partnership's fee-based margin and further reduce its exposure to commodity prices. In the fourth quarter, MarkWest achieved a 65% fee-based margin, up 12% year-over-year, and expects more than 70% of its operating margin in 2014 to come from fee-based projects, which provides greater stability to cash flows.  

Risk factors to consider
Despite MarkWest's leading position in the Marcellus and Utica and its strong prospects for distribution growth, investors should be aware of the partnership's reliance on equity issuances to fund growth -- a practice that has significantly hindered per-unit distribution growth. Investors should also note that MarkWest's distribution coverage ratio dipped to a worrying 0.94x  last quarter.

To improve its distribution coverage ratio, the partnership will have to grow DCF at a faster rate than its distribution. To be fair, this scenario certainly looks achievable and MarkWest expects both DCF and DCF per unit to increase significantly over the next few years as it executes on its growth plans. It also expects to deliver per-unit distribution growth ranging from the high single digits to the mid-teens starting in 2015, which should alleviate investor concerns to some extent.

In addition to equity and debt financing, MarkWest also has access to a credit facility that matures in September 2017 with a borrowing capacity of $1.2 billion, which gives it additional liquidity to pursue its growth projects. Further, the partnership's long-term debt, which stood at $3.02 billion as of year-end 2013, doesn't mature until 2020 and beyond, by which time its growth projects will be generating plenty of cash to pay off that debt.

The bottom line
Overall, MarkWest appears poised for stronger per-unit distribution growth after 2015 once its slate of growth projects in the Marcellus and Utica begin to generate income. Though the company's distribution coverage ratio dipped to just under 1x last year, it should improve slightly this year as DCF grows. While MarkWest doesn't appear particularly cheap on a price to cash flow basis, it still may be a good income play on continued growth in the Marcellus shale.