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Over the past year, the energy sector has been hit hard because of the huge decline in oil and gas prices. This has affected energy stocks regardless of the underlying business model. Even midstream master limited partnerships like Enterprise Products Partners (NYSE: EPD) and Magellan Midstream Partners (NYSE: MMP) are down significantly this year, despite their relatively resilient fundamentals.
The great thing about midstream MLPs is high dividends, made possible by their robust cash flow. Even though energy prices have collapsed this year, companies in the midstream business, which own and operate oil and gas pipelines and storage facilities, haven’t seen cash flow drop significantly.
In fact, Enterprise Products and Magellan Midstream have continued to grow their cash flow and distributions throughout the oil crash. For that reason, income investors should view these high-yield MLPs with high regard.
Think of MLPs as Toll Roads
Perhaps the easiest way to understand the MLP business model is to think of MLPs as toll roads. Just as toll roads collect tolls from cars, MLPs collect fees for the materials being transported through the pipelines and storage terminals. In this way, MLPs are not highly reliant on a supportive commodity price; rather, cash flow is based on volumes.
Midstream companies are somewhat exposed to commodity prices, but not nearly to the extent of their peers in the broader energy sector. This has kept midstream MLPs’ cash flows and distributions growing. While many upstream E&P companies are cutting distributions or suspending them altogether, the well-run midstream operators can maintain their high distributions.
Enterprise Products reported record natural gas liquids, crude oil, petro-chemical and refined products transportation last quarter. Crude oil volumes rose 13%, while volumes of refined products and petrochemicals rose 9%. This helped distributable cash flow excluding asset sales grow by 5% last quarter, year over year.
Magellan’s large crude oil business grew operating profit by 45% last quarter, year-over-year, thanks to a 40-mile Houston crude oil pipeline the company acquired last November.
Focus on Distributable Cash Flow
Instead of evaluating midstream MLPs through the lens of GAAP earnings per share, it is more useful for investors to focus on distributable cash flow, or DCF. DCF is a key metric for MLPs that determines how much cash flow can be distributed to investors. It is a better gauge of the sustainability of their distributions than earnings per share, because DCF excludes significant non-cash items like depreciation.
For example, Enterprise Products grew DCF excluding asset sales by 5% last quarter, year over year, to $988 million. That easily covered Enterprise Products’ distribution last quarter by 1.3 times, which implies sufficient distribution coverage.
Magellan’s distributable cash flow rose 14% last quarter. Going forward, management’s full-year forecast calls for $880 million in DCF, resulting in 1.3 times its expected distributions for 2015.
DCF Fuels Distribution Growth
Last quarter, Enterprise Products raised its annualized distribution to $1.52 per unit. That represented a 5.6% year-over-year increase. It has now come through with 53 distribution increases since its initial public offering in 1998. And Enterprise Products has increased its quarterly distribution for 44 quarters in a row.
For its part, Magellan Midstream recently raised its annualized distribution to $3.05 per unit, which is 14% growth year-over-year. Magellan has now come through with 54 distribution increase since its initial public offering in 2001. Management is committed to increasing the annual cash distribution by 15% for 2015 and at least 10% next year.
Enterprise Products and Magellan Midstream currently yield 5.8% and 4.7%, respectively. Those yields easily beat the stock market average, and since their cash flow continues to grow, their distributions will continue to grow as well. Income investors looking for sustainable high yields should take a closer look at these two high-quality MLPs.
No matter where gas prices go – you get paid
Gas prices have been moving down for a lot of the country – thanks to fluctuations in crude prices. So finally, average American’s are getting a little relief at the pumps. However, one group of folks are taking it one step further – and letting big oil companies pay them to fill up. And believe it or not – it’s all part of an exclusive US Government program. And if you’re eligible, you could collect up to $310 in Gas Rebates very soon.