Master limited partnerships (MLPs) are a vital cog in the energy sector. Many of these companies operate essential infrastructure assets that collect, transport, separate, and store oil and gas — taking it from the wellhead to end users — typically earning a fee for each step along the way. Those payments enable these companies to generate relatively predictable cash flow, giving them the money to pay lucrative distributions to investors.
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Not all MLPs are the same, though the best ones share the following characteristics:
- They get a significant percentage of their cash flow from stable fee-based assets, with more than 90% an ideal level.
- They have an investment-grade credit rating, backed by a debt-to-EBITDA ratio of less than 4.0.
- They have a healthy distribution coverage ratio of 1.2 or better.
While many MLPs meet some of those criteria, five stand out as either currently meeting them all or well on their way toward achieving each goal:
|
MLPs |
Coverage Ratio |
Leverage Ratio |
% of Cash Flow From Predictable Sources |
|---|---|---|---|
|
Enterprise Products Partners (NYSE: EPD) |
1.2 |
3.8 |
92% |
|
Magellan Midstream Partners (NYSE: MMP) |
1.2 |
3.5 |
85%+ |
|
MPLX (NYSE: MPLX) |
1.3 |
3.6 |
95% |
|
Plains All American Pipelines (NYSE: PAA) |
1.5 |
4.7 |
90% |
|
Williams Partners (NYSE: WPZ) |
1.2 |
4.5 |
95% |
The top dog
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Enterprise Products Partners is the cream of the crop in the MLP sector. Not only is it one of the largest integrated energy midstream companies in the country, but it also has one of the strongest financial profiles among MLPs, including a top-tier credit rating. The company thus has unparalleled access to low-cost capital, which gives it the money to build and buy additional fee-bearing assets. In fact, Enterprise currently has $9.1 billion of expansion projects under way, giving it the visibility to continue steadily increasing its distribution to investors each quarter through at least the end of 2019. Meanwhile, with a distribution yield approaching 7%, Enterprise currently sells for its lowest valuation in years, even as its payout grows increasingly safer, making it a top choice for MLP investors.
A model of stability
Magellan Midstream Partners’ financial profile is right up there with Enterprise at the top of the heap, tying it for the best credit rating in the sector. The company therefore has also had no trouble securing money to build expansion projects that have increased its cash flow. At the moment, the company has $1.75 billion of projects under construction through 2019, which will provide it with enough cash flow to boost its payout by 8% this year and in 2018. Furthermore, these projects are primarily fee-based and will further bolster the overall stability of the company’s cash flow. Finally, while Magellan isn’t as cheap as Enterprise and has a lower yield of 5.3%, it’s still a top-notch MLP that should continue creating wealth for long-term investors.
A major catalyst under way
MPLX has grown significantly since its formation five years ago, thanks to a steady stream of drop-down transactions with parent company Marathon Petroleum (NYSE: MPC), as well as third-party acquisitions and organic growth projects. At the same time, MLPX and Marathon are in the process of completing a series of transactions that should significantly increase the MLP’s earnings capacity. These initiatives included dropping down Marathon’s remaining logistics assets to MPLX in an $8.1 billion deal by the first quarter of next year and exchanging the costly incentive distribution rights held by Marathon for additional units of its MLP.
Once they complete these transactions, MPLX will have a stronger coverage ratio, which should provide it with the financial capacity to internally finance organic growth projects so it can continue increasing its distribution, with plans for a double-digit increase for 2018. The completion of this transaction could send MLPX much higher, which is why investors might want to consider buying before the deal closes so they can lock in its compelling current yield of 6.2% and that upside potential.
Rebuilding the foundation for a better tomorrow
Plains All American Pipeline has had a rough year. Units are down about 40% because of weakness in the company’s supply and logistics business, which has been under pressure from low commodity prices and intense competition. For that reason, and because a weaker financial position than its peers, the company slashed its distribution earlier this year. However, Plains made that drastic move to free up about $1.1 billion in cash flow through early 2019, which should enable the company to more quickly get leverage down to its target range of 3.5 to 4.0 times EBITDA.
Meanwhile, the company expects its earnings to turn around next year, as its in-process growth projects start entering service. These initiatives position Plains for “sustainable multi-year distribution growth in 2019, underpinned by healthy fee-based distribution coverage,” according to CEO Greg Armstrong. In the meantime, investors can still collect a compelling 6.4% yield while they wait for the company’s turnaround plan to start paying dividends over the next year.
Repositioned and ready to grow
Williams Partners recently completed a similar repositioning program. Those initiatives included selling several billion dollars in non-core assets to pay down debt and reducing the distribution so it could retain some cash flow and internally finance a portion of its high-return growth projects. As a result, the company is on a firmer financial foundation, which puts it on pace to deliver 5% to 7% annual distribution growth for the foreseeable future, even as it maintains a healthy coverage ratio and improves leverage further. Yet despite the payout cut, Williams Partners offers investors the highest current yield in this group at 7.5%, providing yield-seekers with an attractive income stream.
Excellent income for less risk
These MLPs either have the strongest financial profiles in the sector or a clear plan to get in that top tier quickly, which makes it increasingly likely that they can sustain their current distribution rate to investors. In addition, each has visible growth prospects thanks to in-process expansion projects, which should enable them to increase shareholder distributions in the coming years. That low-risk income growth is what makes these MLPs the top ones to buy right now.
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Matthew DiLallo owns shares of Enterprise Products Partners. The Motley Fool recommends Enterprise Products Partners and Magellan Midstream Partners. The Motley Fool has a disclosure policy.
