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An MLP Hits the Buffet

By Ari Charney on March 17, 2017

Some day, we hope to create the perfect stock screen—one that accurately reveals each company’s virtues and flaws.

Until then, we’re stuck with the inherent shortcomings of data. Indeed, it seems no amount of stats about a company’s performance can ever tell the full story.

We were reminded of this just yesterday, when we dusted off a screen that we’d previously used to find potential recommendations for Investing Daily’s Utility Forecaster.

This particular screen (we have more than 30) was originally set up to find midstream master limited partnerships (MLPs) with solid distribution coverage and low debt.

This time around, however, we augmented our search with additional growth-oriented criteria. Our hope was to find a relatively conservative MLP that has strong projected future cash-flow and distribution growth.

One of the more seemingly promising names to emerge from this search was MPLX LP (NYSE: MPLX), the MLP subsidiary formed by refinery giant Marathon Petroleum Corp. (NYSE: MPC).

MPLX fulfilled many of our criteria. In addition to covering its distribution by a solid 1.23 times in 2016, the midstream MLP also carries a significantly lower debt burden than its peers.

The firm made its market debut toward the end of 2012, so its yield hasn’t yet reached the dizzying heights of some MLPs that have been around for longer. But given its conservative leverage profile (at least as of year-end 2016), MPLX’s forward yield of 5.8% is actually pretty attractive.

More important, the MLP is targeting double-digit distribution growth over the next two years. The partnership has boosted its payout every single quarter since its first distribution, resulting in distribution growth of 20.6% annually over the past three years. So we already know it’s no slouch when it comes to sharing the wealth with unitholders.  

Based on analyst forecasts for future distributions, units of MPLX that are bought today could be yielding 7.2% by the end of next year. Now you’re paying attention!

Of course, it will take higher cash flows to drive future distribution growth. To this end, we noticed that MPLX has one of the strongest forecast EBITDA (earnings before interest, taxation, depreciation, and amortization) growth trajectories in the sector. Over the next three years, EBITDA is projected to grow 137.3%, to $3.4 billion.

But that jump in EBITDA won’t happen via internal growth. And that’s where MPLX becomes an MLP to watch, rather than an MLP to buy now.

Wait … What?

There are a number of goodies coming to the MLP from its sponsor, including asset dropdowns and the elimination of onerous incentive distribution rights (IDRs).

The latter give the MLP’s general partner a rising share of distributable cash flow once certain distribution targets are hit. MPLX is already in what’s known as the high splits, which means that Marathon is now siphoning off 50% of quarterly distributable cash flow above the $0.393750 per unit level.

As such, the elimination of IDRs will improve distribution coverage, while providing a longer runway toward future distribution growth.

But MPLX unitholders won’t get these goodies for nothing. These transactions will be funded with a mix of debt and equity. And the accelerated schedule for realizing the transfer of all these assets means that MPLX will have a number of debt and equity issuances this year.

If all goes according to plan, the $13 billion MLP will be acquiring $9 billion to $11 billion worth of midstream assets via dropdown transactions. Based on our survey of recent deals in the sector, the valuation that Marathon is seeking for these assets seems quite fair.

Less fair, however, is the price that it’s seeking for its general partner/IDR interests, a multiple of 15.0 times to 20.0 times annual GP/IDR distributions. That would put the deal value for eliminating the IDRs at around $9 billion to $12 billion.

That’s a lot of action for a $13 billion MLP in a relatively short time. The good news is that leverage should remain at a reasonable level, since MLPs typically fund deals with a 50/50 debt-to-equity split. The bad news is that there will be a huge amount of near-term dilution for unitholders to swallow.

Consequently, we’d rather monitor this situation from the sidelines.


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