This guest contribution is from Bob Ciura at Sure Dividend.
Income investors might be naturally drawn to the Master Limited Partnerships, otherwise referred to as MLPs. This asset class provides a number of benefits for investors, including potential tax benefits as well as higher yields. Many MLPs provide high distribution yields of 5% or even more in some cases.
That said, investors should also understand the potential risks of investing in MLPs. These are often companies in the oil and gas industry. And, investing in MLPs typically requires a little more paperwork come tax season, due to the K-1 forms issued by MLPs.
For investors who have fully considered all the various aspects of MLPs and decided they would like to invest, we have high rankings on the following 3 MLPs.
Top MLP #1: Energy Transfer LP (ET)
Our top-ranked MLP right now is Energy Transfer, which has a very high yield of 9.6%. Not only do we find Energy Transfer’s nearly double-digit yield to be attractive for income investors, but the distribution appears secure due to the company’s strong cash flow.
Energy Transfer owns and operates natural gas transportation and storage assets along with crude oil, natural gas liquids and refined product transportation and storage assets. In all, the company operates over 80,000 miles of pipelines. Energy Transfer also owns the Lake Charles LNG Company, as well as investments in publicly traded Sunoco LP (SUN) and USA Compression Partners (USAC).
As a midstream MLP, Energy Transfer collects income based on the volumes transported and stored through its assets. MLPs operate similarly to toll roads. In this way, midstream MLPs are somewhat shielded from the price of the underlying commodity—volumes are far more important drivers of cash flow. This is what allows Energy Transfer to maintain such a high distribution payout.
Over the first three quarters of 2019 (the company has not yet reported full-year financial results), Energy Transfer maintained a distribution coverage ratio of 1.98x. This represents a highly secure distribution, and was an increase from 1.68x in the same nine-month period of 2018. In other words, Energy Transfer would need to see its distributable cash flow fall by nearly 50% in order for its distribution to no longer be sufficiently covered by DCF.
Future distribution growth is possible, thanks to the company’s strong assets and also the recent $5 billion acquisition of SemGroup. The acquisition expanded Energy Transfer’s natural gas liquids and crude oil capabilities with the addition of 18.2 million barrels of storage capacity. Overall, we expect ~3% annual DCF growth for Energy Transfer.
Lastly, the units appear underpriced at a trailing P/DCF multiple of just 5.8. Our fair value estimate is a P/DCF multiple of 8. The combination of valuation expansion, DCF growth, and the 9.6% distribution yield could lead to excellent total returns for Energy Transfer over the next five years.
Top MLP #2: MPLX LP (MPLX)
MPLX, LP is an MLP that was formed by Marathon Petroleum Corporation (MPC) in 2012. The business operates two segments. First, the Logistics and Storage segment relates to crude oil and refined petroleum products. The Gathering and Processing segment relates to natural gas and natural gas liquids (NGLs).
MPLX is among the highest-growth MLPs in our coverage universe. 2019 was a very strong year of growth for MPLX. Distributable cash flow increased 13% on a per-unit basis last year, to $4.52 per unit. As a result, the distribution coverage ratio expanded to 1.51x in 2019, from 1.49x in 2018. Investors should also note that the company’s leverage ratio (defined as debt-to-adjusted EBITDA) also expanded, to 4.1x from 3.9x in the previous year.
While investors should closely monitor the company’s future debt levels, we believe MPLX is an attractive MLP for growth and income. MPLX units have declined 31% in the past 12 months, but the company continues to execute on its strategic growth initiatives. As a result of this price decline, units now yield 11.6%.
Plus, MPLX continues to raise its distribution on a regular basis. For example, on January 23 the company increased its quarterly distribution by 6.2% compared with the same distribution last year. MPLX has now raised its distribution for 28 quarters in a row. In addition, the company’s strong financial results in recent quarters leads us to expect 2% annual DCF growth.
MPLX in particular has a strong position in the Marcellus/Utica region, with long-term contracts from Marathon. Growth will be supplemented by the 2019 acquisition of Andeavor Logistics. The $9 billion transaction ($14 billion including debt) expanded MPLX’s strong footprint in the Marcellus and Permian Basin.
We view MPLX as an undervalued MLP, with a P/DCF ratio below 6, compared with our fair value estimate of 7. The combination of valuation multiple expansion, DCF growth, and distributions could lead to total annual returns in the high-teens.
Top MLP #3: Enterprise Products Partners (EPD)
Enterprise Products Partners is another midstream MLP, with a top-tier network of assets that includes nearly 50,000 miles of natural gas, natural gas liquids, crude oil, and refined products pipelines. It also has storage capacity of more than 250 million barrels.
Enterprise Products had a very strong year in 2019. Adjusted EBITDA increased 12% for the year, while distributable cash flow increased 11% due to higher volumes and contributions from new assets. Enterprise retained $2.7 billion of DCF for 2019, a 24% increase from the previous year. This allows the company to return significant cash to unitholders.
Indeed, Enterprise Products has increased its distribution for 62 consecutive quarters, and for 21 years in a row. The company expects to increase the quarterly distribution by $0.0025 per unit in each quarter of 2020. In total, this would result in 2%-3% distribution growth for 2020.
Enterprise Products also intends to use approximately 2% of its 2020 cash flow from operations to buy back its common units in the upcoming year. Buybacks are very rare among MLPs, and indicates the strength of the company’s business model and financial position.
Another reason we rank Enterprise Products highly is because it has a very strong balance sheet and distribution coverage. It has credit ratings of BBB+ from Standard & Poor’s and Baa1 from Moody’s, which are higher ratings than most MLPs. It also had a high distribution coverage ratio of 1.7x for 2019. These qualities indicate that the company’s distribution is highly secure.
With a nearly 7% yield, promising future growth potential, and a rock-solid balance sheet, Enterprise Products is one of the strongest MLPs. Trading at a P/EBITDA ratio below 7, compared with our fair value estimate of 10, we view Enterprise Products as significantly undervalued. Total returns could reach 19% per year over the next five years, due to ~4% annual business growth, the 6.8% yield, and expansion of the valuation multiple.
