The master limited partnership (MLP) structure often comprises two entities: a limited partnership that owns the underlying assets and a general partner (GP) that’s responsible for managing the operating entity.
In addition to a minority stake in the limited partnership, the general partner holds incentive distribution rights (IDR) that entitle it to an incrementally higher percentage of the LP’s distributable cash flow as the payout reaches certain predetermined thresholds.
This arrangement effectively motivates the GP to pursue initiatives that will enable the operating MLP to grow its cash flow and quarterly disbursements to unitholders; a rising payout at the LP level translates into disproportionate increases to the GP’s incentive distribution. Many GPs also own a significant percentage of the LP’s common units.
As the MLP achieves certain distribution targets laid out in the partnership agreement, the IDR schedule allocates a growing proportion of the LP’s cash flow to the GP.
The first interval of these sharing arrangements usually starts with the GP receiving 2 percent of cash flow designated for disbursement and the LP unitholders receiving 98 percent. Meanwhile, the top tier of the IDR schedule–the “high splits” in industry parlance–often entitles the GP to about 50 percent of incremental cash flow.
That is, in order to raise the LP distribution by $0.01 per unit, the MLP would need to pay a corresponding $0.01 to the GP for each outstanding LP unit. (Elliott discusses the ins and outs of the IDR schedule and its implications in The Lowdown on MLP IDRs: Incentive or Impediment.)
The distributable cash flow allocated to the GP also increases when the LP issues equity; the general partner is entitled to receive additional payments for each additional LP unit.
Although shares of pure-play GPs tend to offer inferior yields relative to the associated LP units, investors shouldn’t overlook the importance of a growing quarterly payout to a stock’s performance: Not only do rising distributions increase the current return, but they also tend to capture investors’ attention and drive stock prices higher.
Your complete guide to energy investing, from growth stocks to high-yielders.
In October 2012, renowned energy expert Elliott Gue launched the Energy & Income Advisor, a twice-monthly investment advisory that's dedicated to unearthing the most profitable opportunities in the sector, from growth stocks to high-yielding utilities, royalty trusts and master limited partnerships.
Elliott and Roger on Mar. 30, 2017
Balanced portfolios of energy stocks for aggressive and conservative investors.
Our take on more than 50 energy-related equities, from upstream to downstream and everything in between.
Our assessment of every energy-related master limited partnership.
Roger Conrad’s coverage of more than 70 dividend-paying energy names.