Energy Transfer Partners: An MLP on the Move
Master limited partnerships (MLPs) showed steady gains in 2013, with the benchmark Alerian MLP index rising 20.4% (not including distributions) from January through December.
It was a particularly good year for the index’s sixth-largest constituent by market cap, Energy Transfer Partners LP (NYSE: ETP), whose unit price gained 31.1%.
That marked a big turnaround from 2012, when the MLP underperformed the index by a significant margin. Two important factors contributed to last year’s improvement: the resumption of dividend hikes (or distributions, as they’re called in the MLP universe) after a five-year hiatus and a key acquisition.
More on those—and an in-depth look at Energy Transfer Partners’ operations—below. First, if you’re not familiar with MLPs, here’s a quick primer.
MLPs trade on stock exchanges, just like stocks, and you can easily buy them through any broker. They raise capital by issuing units, which are the equivalent of shares in a common stock. When you purchase an MLP, you’re known as an LP unitholder.
But a more important difference is that MLPs don’t pay tax at the corporate level. Instead, they pass through most of their income to investors in the form of regular distributions, which investors then pay individual tax on.
Moreover, the IRS generally treats 80% to 90% of the distribution you get from an MLP as a return of capital, which is not taxable when received. Instead, returns of capital reduce the cost basis of an investment in the MLP. In other words, 80% to 90% of the distribution you get from an MLP is tax-deferred, while the rest is taxed at your income tax rate.
MLPs are also structured differently than corporations: in addition to LP unitholders, they typically include a general partner (GP), which manages the MLP’s day-to-day operations.
GPs benefit from this arrangement in two ways: first, most own LP units and receive distributions just like other unitholders. They also receive “incentive distribution rights” (IDRs), which is a sort of management fee that rises based on prearranged criteria.
For example, Energy Transfer Equity LP (NYSE: ETE) owns Energy Transfer Partners’ GP, along with 100% of its IDRs.
Energy Transfer Partners: A History of Aggressive Expansion
Now that you’ve got a grasp of the basic structure of MLPs, let’s zero in on Energy Transfer Partners, a broad-based MLP that’s a buy recommendation of our MLP Profits advisory.
Dallas-based Energy Transfer Partners was founded in 2002, when it operated 200 miles of natural gas pipelines in Texas. It became a publicly traded partnership in 2004. It then completed a string of acquisitions over the following two years that vastly expanded and diversified its operations.
These purchases included the TUFCO pipeline system, which added 2,000 miles of natural gas pipelines and storage facilities; the Houston Pipeline System (3,900 miles of gas pipelines and related storage); and the Transwestern pipeline (2,560 miles of gas pipelines).
From 2007 to 2010, the MLP went through what it calls its “major organic growth period,” when it completed and started up 2,000 miles of pipelines in large U.S. shale plays, including the Barnett, Fayetteville and Haynesville shales. It also opened its Godley plant, which processes natural gas from the Barnett shale.
Today, Energy Transfer Partners boasts a market cap of $17.8 billion and operates 43,000 miles of natural gas, natural gas liquids (NGL) and refined products pipelines. Through acquisitions and organic growth, it has increased its exposure to a number of growing markets, from NGLs, such as propane and butane, to liquefied natural gas (LNG) and even gas stations.
For example, it holds 70% of Lone Star NGL, a joint venture that owns and operates natural gas liquids storage, fractionation and transportation assets in Texas, Louisiana and Mississippi. (Fractionation is the process of separating individual NGLs after they’ve been removed from the gas stream.)
Big Acquisition Plays a Key Role
In October 2012, Energy Transfer Partners closed its $5.3-billion purchase of Sunoco Inc. The deal gave it Sunoco’s GP interest and incentive distribution rights in Sunoco Logistics Partners LP (NYSE: SXL), as well as a 32.4% LP stake in that MLP.
The move also expanded the MLP’s exposure to oil and NGLs: Sunoco Logistics operates 7,900 miles of crude oil, NGL and refined product pipelines that give Energy Transfer Partners a presence in the growing Utica and Marcellus shales, in addition to shipping terminals and 4,900 gas stations in the eastern U.S.
The acquisition was part of the company’s plan to increase its focus on more lucrative oil and NGLs at a time of low gas prices.
Reflecting its focus on investing in growth projects, Energy Transfer Partners had held its distribution steady since 2008. However, it resumed distribution hikes in September 2013 and has increased its payout three times since. The current quarterly rate of $0.935 a unit ($3.74 annualized) is up 4.6% from a year ago and yields 6.7%.
In the first quarter, Energy Transfer Partners’ revenue rose 12.7%, to $12.23 billion from $10.85 billion a year ago. Net income rose to $0.76 a unit from $0.63. Distributable cash flow jumped 67.3%, to $629 million, enough to cover its distribution by a comfortable 1.36 times.
The strong first quarter was positively affected by the partnership’s continued asset growth, higher commodity prices and increased shipping volumes.
In addition, the partnership recently announced that it has entered into 15-year agreements with Mexico’s electricity agency to ship 930,000 MMBtu (million British thermal units) of natural gas a day to that country. This is a growing market, as natural gas continues to displace oil as a feedstock in Mexican power generation.
Finally, Energy Transfer Partners has also agreed to pay $1.8 billion for Susser Holdings Corp. (NYSE: SUSS), which operates 630 convenience stores in Texas, Oklahoma and New Mexico. The partnership sees the acquisition as another step toward eventually setting up its retail outlets as a stand-alone business.
Energy Transfer Partners’ revenue looks set to keep rising as it benefits from its recent acquisitions and surging U.S. oil and gas production. It should take the MLP’s distribution along with it as it does.
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