Source: Shell Midstream Partners
Low energy prices are putting the hurt on some big midstream MLPs, potentially threatening investors with distribution cuts. On the other hand, there are midstream MLPs such as Shell Midstream Partners (NYSE: SHLX), which are growing quickly and racking up some of the most impressive payout growth of any dividend stocks in America.
Let's examine three reasons Shell Midstream's stupendous payout growth is likely to continue into 2016 and far beyond, no matter how long low energy prices persist.
Amazing growth courtesy of drop downs
| Metric | Q3 2015 | Q1 2015 | Six Month Change |
|---|---|---|---|
| Adjusted EBITDA | $57.1 million | $28.5 million | 100% |
| Distributable cash flow (DCF) | $46.4 million | $30.9 million | 50% |
| Quarterly distribution | $0.205 | $0.175 | 17% |
| Distribution coverage ratio (DCR) | 1.5 | 1.3 | 15% |
Source: Shell Midstream earnings release, 10-Q.
Shell Midstream Partners IPOed in late 2014, so it's too new to have year-over-year results. However, over the last six months the MLP has put up some amazing growth results. This performance is a result of $1.2 billion in dropdowns the MLP has thus far purchased from its sponsor and general partner, Royal Dutch Shell (NYSE: RDS-A) (NYSE: RDS-B). In fact, on Nov. 11, Shell Midstream announced the $390 million acquisition of the Lockport Terminal and Auger pipeline system from a subsidiary of Shell.
The price of the dropdown was 8.6 times 2016's projected adjusted EBITDA, which is a slightly high valuation, given that we're currently experiencing the worst oil crash in decades. However, the deal is still immediately accretive to DCF per unit, which means Shell Midstream investors should still count it as a major win.
That's especially true given that, year to date, Shell Midstream has converted a 93% of adjusted EBITDA into DCF. This is likely because its a new MLP and so has very low maintenance and interest costs. However, those factors also mean that this latest deal potentially could generate $42.2 million in additional DCF for 2016, representing a 28% increase in annual DCF next year.
To pay for the dropdown, Shell Midstream is selling up to 9.2 million units at $32.54 per unit, grossing it around $300 million minus the usual underwriter discounts and fees.
Thus, this secondary offering represents an 11% increase in unit count. However, DCF per unit could potentially increase 15%. That means this single dropdown could potentially allow Shell Midstream to raise next year's distribution -- a kind of tax-advantaged dividend -- by 15% while still maintaining a DCR of 1.5, which is one of the highest coverage ratios in the industry.
One of the best dividend growth choices you can make
Speaking of coverage ratios, Shell Midstream Partners' high and rising DCR makes its distribution profile one of the most impressive in the MLP industry. Not only is the 2.5% yield higher than the 2% an S&P 500 index fund offers, but Shell Midstream Partners has a year-to-date coverage ratio of 1.4, meaning it's generated almost $46 million in excess DCF in 2015.
That's cash that not only ensures the quarterly payout but can be reinvested into buying other fee-based midstream assets from Royal Dutch Shell and keeping the growth party going strong for years to come, even in a low energy price environment.
So Shell Midstream offers a decent yield and bank vault-like payout security, but where its distribution profile really shines is long-term payout growth potential. Right now, analysts estimate that the MLP will grow its distribution at 28.1% CAGR over the next five years.
Excellent liquidity position because of its strong balance sheet
While I think such an impressive distribution growth rate is possible, I'd prefer if management continue the conservative approach it's taken thus far. Specifically, I mean growing the payout slower than DCF per unit. Doing so would raise the DCR over time and mean the MLP would have a growing source of excess DCF with which to fund even more dropdowns from Shell, organic growth projects, or third-party acquisitions.
This excess cash flow could also help keep the balance sheet strong, thus improving the MLP's credit rating and lowering long-term borrowing costs.
Bottom line: Low oil prices can't stop Shell Midstream's super growth
Shell Midstream's superb, fee-based tollbooth business model and immense excess DCF capacity is a dividend lover's dream in this time of low-energy-price uncertainty. When you factor in the immense dropdown pipeline that Royal Dutch Shell has to offer its MLP, it's hard not to get excited by the distribution growth implications.
With a strong balance sheet likely to make further credit facility expansion relatively easy, and Wall Street still offering attractively priced equity growth funding, it looks like smooth sailing for Shell Midstream to continue its amazing dropdown and distribution growth story for many years to come.
