This Marcellus-Focused MLP Looks Like a Solid Buy

Why EQT Midstream Partners’ massive growth opportunities in the Marcellus shale should support 20% annual distribution growth over the next three years.

Arjun Sreekumar
Arjun Sreekumar
Apr 29, 2014 at 12:20PM
Energy, Materials, and Utilities

With interest rates still very low by historical standards, master limited partnerships, or MLPs, stand out as one of the more attractive investment opportunities for income-seeking investors.

EQT Midstream Partners (NYSE:EQM), a midstream partnership that offers transmission, storage, and gathering services to upstream producers in the Marcellus shale, is worth a closer look because of its extremely strong distribution growth prospects, robust balance sheet, and exposure to one of the fastest-growing shale gas plays in the country.

Photo credit: Chesapeake Energy.

A brief overview
EQT Midstream Partners is a master limited partnership formed by EQT (NYSE:EQT) to own, operate, acquire, and develop midstream assets in the Appalachian Basin. The partnership provides various transmission, storage, and gathering services to its general partner EQT, which is its largest customer and one of the leading drillers in the Marcellus, and other upstream producers through two main assets: its transmission and storage system and its gathering system.

Since the partnership's revenue depends on system throughput and contracted transmission capacity, which are typically negotiated under long-term contracts with fixed reservation and/or usage fees, its revenue and cash flow are highly stable and have limited commodity price exposure. To boost its system throughput and transmission capacity, the partnership has an aggressive expansion plan that includes organic growth projects, drop-downs from sponsor EQT, and third-party opportunities.

Expansion projects to drive significant DCF growth
This year, the partnership expects to spend $100 million-$105 million on expansion projects. Major projects include the Jefferson compressor station expansion, which will boost the capacity of its transmission and storage system by roughly 550 BBtu per day once it is completed by the third quarter of this year, and the West Side and East Side expansion projects for Antero Resources (NYSE:AR), which combined will provide 200 BBtu per day of transmission capacity once they go into service by year-end 2014 and midyear 2015.

The partnership will also expand its transmission capacity by an additional 100 BBtu per day by year-end 2014 for Range Resources (NYSE:RRC). Crucially, cash flows from both projects are highly stable since Antero and Range have signed fixed-fee, 10-year contracts. In total, these expansion projects will boost the partnership's total transmission system capacity by about 850 BBtu per day, or 40%, to 3 TBtu per day by the end of the year, providing a big boost to EBITDA and distributable cash flow.

Indeed, the partnership recently raised its full-year 2014 adjusted EBITDA forecast to $186 million-$188 million and distributable cash flow forecast to $164 million-$166 million, following better than expected first-quarter results and higher projected throughput from both EQT and third-party producers.

Exceptional distribution growth prospects
Reflecting its confidence in stronger EBITDA and DCF growth, the partnership also recently announced a cash distribution of $0.49 per unit for the first quarter of 2014, up 32% from the prior-year period. This marks the fourth-consecutive quarter in which the partnership has raised its distribution by $0.03 per unit each quarter -- a rate of growth it expects to maintain at least through the end of 2015. This guidance represents an annual distribution per unit increase of 29% this year and 22% in 2015.

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Crucially, the partnership's distribution coverage ratio stood at a very healthy 1.56 times as of the end of the first quarter, which means it has a 56% cash cushion after paying out distributions. As it pursues its growth strategy over the next few years, EQT Midstream will target a 1.1 times coverage ratio.

EQT Midstream also looks solid from a balance sheet and liquidity perspective, with no long-term debt and net debt of about $86 million as of the end of the first quarter. It also has access to a revolving credit facility that was increased from $350 million to $750 million during the first quarter, giving the company ample financial flexibility to pursue its growth strategy.

Investor takeaway
Supported by its strategic location in the Marcellus shale, the fastest-growing shale gas play in the country, EQT Midstream Partners has numerous organic growth opportunities that should deliver stable and growing cash flows over the next few years. Though it yields just 2.5%, annual distribution growth of about 20% over the next three years should support yield growth. And with no long-term debt, sufficient liquidity, and growing third-party opportunities, the partnership looks like a solid buy right now.