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MLPs: The Quest for Sustainability

By Roger S. Conrad on Nov. 5, 2017

With investor confidence in master limited partnerships (MLP) at low ebb, inflows to the group have slowed significantly, reducing the market’s capacity to absorb equity issuance. Many debt-constrained MLPs with higher yields have responded to this challenge by pursuing private placements of preferred units to finance growth projects or asset drop-downs.

A strong balance sheet and excess distribution coverage enabled Enterprise Products Partners LP (NYSE: EPD) to take a slightly different tack: reducing its rate of quarterly distribution increases to retain more cash flow.

With Enterprise Products Partners not getting credit for its consistent growth, management indicated that reducing the rate of distribution increases would put the MLP closer to being able to self-fund the equity portion of its growth capital in 2019—a major point of differentiation. Management asserted that any excess cash flow eventually could be used to buy back stock, depending on the valuation and how this option stacks up relative to other uses of capital.

This announcement from an industry bellwether raised questions about whether the traditional model of pushing the envelope on distribution growth while relying primarily on equity issuance to finance expansion opportunities still makes sense.

Given the pain of the past several years, a focus on building distribution coverage and improving leverage metrics should help to shore up confidence in the group. And any MLP that can grow its per-unit cash flow without leaning heavily on the equity market will have a distinct advantage as competition for volumes intensifies.

Enterprise Products Partners wasn’t necessarily the first MLP to go down this path—Magellan Midstream Partners LP (NYSE: MMP) hasn’t issued equity since 2010—but this announcement has changed the conversation this earnings season, with many partnerships tapping the breaks on distribution growth to build coverage and reduce the need to issue equity.

Thus far, third-quarter results suggest that most of our MLP Portfolio holdings will be able to make this transition with relative ease, though two names with tighter distribution coverage could face more of a slog.

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