Scooping Up MLP Bargains
It’s August, and the summer has been a cool one across the U.S. East and Midwest. Despite the heat wave in the West, there’s been less need for cooling nationwide than during last year’s record scorcher.
Natural gas still sits below $3/mmBTU, and pipeline stocks remain broadly out of favor.
So of course I’m here to discuss EQT GP Holdings (EQGP), representing gas driller EQT’s (EQT) general partnership interests in its EQT Midstream Partners (EQM).
As the holder of incentive distribution rights in EQM, EQGP gains disproportionally from the pipeline affiliate’s expansion. That expansion is tied closely to the drilling done by EQT, but also benefits from opportunities to ship other producers’ gas along EQM’s growing system south and west of the Marcellus shale.
EQT is set to become the largest gas driller in the U.S. once it closes its pending acquisition of Rice Energy (RICE). No one produces gas more cheaply and few drillers are better capitalized, so there’s a very high likelihood that EQT will be developing its enlarged leaseholds for years.
Historically, such development has built value on the midstream side of the business. Despite the protracted downturn in gas prices and energy equities, the price of EQM units has tripled since they came public five years ago. EQM still yields 5.1% while growing its distribution 19% annually, an attractive combination I highlighted right after the Rice merger announcement.
EQGP is a leveraged play on EQM’s growth currently yielding 3.1%. The distribution is set to increase 40% in 2017 and 30-40% per year thereafter. At that rate, EQGP would be yielding 7.4% at the current unit price by the end of 2020. High compounded growth works its magic quickly.
Of course, we all know how little energy producer forecasts can be worth when they’re based on faulty industry assumptions. The key here is that the forecasts for EQGP are based on low gas prices that can’t go much lower for long if the U.S. is to maintain its energy consumption and export commitments. At these prices, EQM is generating 40% more cash flow than it needs to pay the distributions relied on by EQGP. So odds look good that either the price will rise or EQGP will have a 7% yield while still growing its distributions rapidly three years from now. I’m adding EQGP to the portfolio.
You don’t need to wait to get a high yield in Andeavor Logistics (ANDX); the rebranded successor to Tesoro Logistics is already yielding 8.2% following the merger and restructuring transactions announced this week.
ANDX was merged with its sponsor’s other MLP, Western Refining Logistics, at a token premium for Western’s public unitholders, giving it a toehold in the Permian Basin and an operating footprint stretching from Alaska to Minnesota. At the same time, it bought out its incentive distribution rights obligations to the sponsor in exchange for additional units.
The net result is the aforementioned 8%-plus yield with reasonable leverage (below 4x debt/EBITDA by the end of the year) and modest distribution growth (6% annually).
It’s been a tough summer for all the pipeline master limited partnerships, including ANDX/TLLP. But refinery logistics is a steady business, and Andeavor participates in some very lucrative regional refining markets, including the U.S. Northwest and Southwest.
The 8% yield is ample compensation for the additional risk inherent in the MLP’s gathering and processing operations. Buy the dip. (Note that Tesoro Logistics was included in Income Millionaire’s relaunched portfolio in May, so this is a reiteration of a standing recommendation.)