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A Look at MLP Valuations

By Peter Staas on Apr. 25, 2014

Editor’s Note: We discovered an error in our calculations regarding EV to EBITDA estimates related to Cheniere Energy Partners LP’s (NYSE: CQP) anticipated cash flow from its Sabine Pass LNG export facility. Based on the MLP’s current enterprise value, the multiple would be about 7 times EBITDA in 2019–a much more reasonable valuation. We apologize for any harm this error may have caused. 

Income-seeking investors all too often pick the master limited partnerships (MLP) in their portfolios based on their distribution yields, ignoring critical factors such as the underlying business, growth potential and valuations relative to their peers.

There’s nothing new under the sun. In a March 1987 article published in the Wall Street Journal, Barbara Donnelly wrote: “Investment bankers specializing in [master limited] partnerships say that in order to be competitive an issue must offer a current return of 9 percent to 10 percent.”

Twenty-five years later, it’s still all about the yield for many investors, especially as retiring baby boomers shift their focus from accruing assets to transforming accumulated savings into a reliable income stream.

However, as my colleague Elliott Gue observes in Investing in MLPs: Yield vs Distribution Growth, publicly traded partnerships that grow their distributions over time generally deliver superior total returns than those that offer only a high yield.

Moreover, taking profits on a MLP that has generated a big chunk of its upside from price appreciation entails less of a tax burden than a position that has generated most of its return through distribution accumulation.

Prospective investors should also understand the extent to which an MLP’s relationship with its general partner can enhance or impede its growth prospects.

These days, initial public offerings are often structured so that the parent can monetize its MLP-qualifying assets and achieve the high splits as quickly as possible to maximize its cut of the cash flow. (See MLP Basics: Incentive Distribution Rights Explained.)

Combined with an understanding of an MLP’s underlying business and growth prospects, valuation can help you decide which publicly traded partnerships to add to your portfolio.

The Low End

We’ll start from the bottom and look at the five MLPs that exhibit the lowest enterprise values to earnings before interest, taxation, depreciation and amortization (EBITDA).

There are few surprises among the bottom dwellers, many of which are smaller-cap MLPs with checkered pasts or limited upside.

  • Coal producer Oxford Resource Partners LP (NYSE: OXF) discontinued its quarterly distribution at the start of last year, thanks to weak commodity prices, elevated production costs and excessive leverage.
  • Spun off from fertilizer manufacturer CVR Energy (NYSE: CVU) at the instigation of activist investor Carl Icahn, CVR Refining LP (NYSE: CVRR) owns two refineries in the Midcontinent region and supporting transportation and storage infrastructure. Tumbling crack spreads forced the downstream operator to slash its quarterly distribution, which fluctuates with quarterly cash flows to $0.45 per unit from $1.58 per unit in the second quarter of 2013.
  • Struggling with excessive leverage and weak prices for natural gas liquids (NGL)Eagle Rock Energy Partners LP (NSDQ: EROC) slashed its distribution and late last year announced plans to divest its gathering and processing assets in the Midcontinent region to focus exclusively on its upstream operations. A fatigued management team and the MLP’s recent proxy filing related to the sale of its midstream assets suggest that the upstream portion could also be a takeover target.
  • Star Gas Partners LP (NYSE: SGU), the nation’s leading distributor of home-heating oil, continues to contend with customer attrition to natural gas and relies heavily on acquisitions to drive distribution growth.
  • Alon USA Partners LP (NYSE: ALDW) owns a refinery in west Texas and, like CVR Refining, pays a variable distribution. With the company’s Big Spring refinery undergoing a full turnaround in the first quarter, investors shouldn’t get overly excited about upcoming earnings. Favorable price differentials for West Texas Sour and West Texas Intermediate at the hub in Midland, Texas, could make this name worth a second look.
     

The High End

The opposite end of the spectrum includes a mix of market darlings and a few surprises.

We’re not shocked to see Phillips 66 Partners LP (NYSE: PXSP), one of the hottest initial public offerings (IPO) from last year, on the list. (See Rating the Master Limited Partnership IPOs of 2013.)

Downstream giant Phillips 66 (NYSE: PSX), itself a recent spin-off from ConocoPhillips (NYSE: COP), created the MLP to house the pipelines associated with its refineries.

Not only does Phillips 66 Partners boast a highly visible pipeline of drop-down transactions from its sponsor, but the firm also stands to benefit from higher run rates at its parent’s Gulf Coast refineries.

Tesoro Logistics LP (NYSE: TLLP), a spin-off of refining giant Tesoro Corp (NYSE: TSO), offers exposure to a similar growth story that’s fueled by drop-down transactions from its parent.

But one of the names in our graph sticks out like a sore thumb: Cheniere Energy Partners LP (NYSE: CQP).

As the lone pure play on US exports of liquefied natural gas (LNG) and the first mover in the space, Cheniere Energy Partners has enjoyed low construction costs at its Sabine Pass terminal on the Gulf Coast and its stock commands a significant scarcity premium.

Although the company’s enterprise value stands at about 588 times EBITDA, this valuation shrinks to about 7 time EBITDA in 2019 when you factor in the anticipated cash flow that will be generated by the six trains at its Sabine Pass liquefaction and export facility.

Potential downside catalysts for the stock include the end of the MLP’s scarcity premium–Energy Transfer Equity LP (NYSE: ETE), Dominion Resources (NYSE: D) and Sempra Energy (NYSE: SRE) all plan to house their proposed LNG export facilities in MLPs–and the potential delay or cancellation of its Corpus Christi project.

Subscribers can read more about our top picks and pans in the LNG market in the most recent issue of Energy & Income Advisor, LNG Investment Bible, North American Edition

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