There has been a lot of pain in the pipeline master limited partnership space over the last few years, highlighted by the Alerian MLP Index 45% decline since peaking in 2014. Not all partnerships are the same, however, and industry bellwether Enterprise Products Partners LP (NYSE: EPD) and refining midstream specialist Holly Energy Partners LP (NYSE: HEP) are both high-yield stocks that deserve a second look if you are building an income portfolio today.
Slowing down to get stronger
Enterprise is one of the largest and most diversified midstream partnerships in North America. Its portfolio of largely fee-based businesses includes pipelines, storage facilities, processing facilities, and even a fleet of ships. The units are down roughly 30% from their 2014 highs and yield a generous 6.4%. The distribution, meanwhile, has been raised every single year for 21 consecutive years — including a hike in each of the last 55 quarters.
One of the big issues today is that Enterprise announced that it is going to slow distribution growth in 2018, and perhaps a little longer after that. Over the past decade, Enterprise had been increasing its distribution in the mid-single-digit range. That’s going to slip into the low single digits. This isn’t necessarily a sign of trouble; rather, Enterprise is temporarily slowing its distribution growth so it can self-fund more of its own capital spending. That will reduce its need to sell dilutive units and debt in the future. This is a good move for investors over the long term.
It’s worth noting, as well, that the pipeline giant hasn’t stopped spending on growth. For example, it has $5.3 billion worth of growth projects lined up in 2018 and 2019. Once the partnership has completed this growth phase and reached a new balance between distributions and self-funding, it should be able to start increasing the distribution at a mid-single-digit rate again.
It’s just going to take time to get from here to there, opening up an opportunity for income investors to pick up a big yield while Enterprise is in the bargain bin.
Another shifting midstream company
With a market cap of around $3 billion, Holly Energy Partners is a much smaller midstream company than $60 billion-market-cap Enterprise. However, its business is largely fee-based and has supported distribution increases each quarter since its IPO (a 54-quarter run at this point). The annual streak is up to 14 years. The yield, meanwhile, is a robust 8.7%, largely driven by a unit price decline of 34% since hitting a peak in 2013.
Holly Energy is a bit more aggressive than Enterprise, so a higher relative yield is appropriate. For example, the partnership is targeting distribution coverage of 1 to 1.2 times — Enterprise’s coverage has been 1.2 or higher in each of the last five years (it was 1.5 times in the first quarter largely due to the self-funding shift). Also, unlike Enterprise, it has an external general partner, independent refiner HollyFrontier Corporation. Generally that means incentive distributions are paid to the general partner, which increases a partnership’s cost of capital. But in late 2017, Holly Energy bought those incentive distribution rights.
That came at the cost of issuing 37.25 million new units, a clear drag on per-unit results. In an effort to make the deal more palatable, HollyFrontier agreed to waive $2.5 million worth of distributions for three years. That should allow Holly Energy time to grow into the larger unit count.
Holly Energy believes this transaction will lower its cost of equity capital by as much as 3.5 percentage points, which is going to be important because HollyFrontier has few additional assets to sell to Holly Energy to fuel its distribution growth. That means internal projects (it has $50 million worth of expansion projects planned for 2018) and third-party acquisitions (either in partnership with HollyFrontier or on its own) will be key. That’s a much less certain future than what investors are used to from this partnership, which further explains the high yield.
However, for more aggressive investors willing to shoulder some near-term uncertainty for a higher yield, Holly Energy is worth a deep dive while it’s in the discount bin. Like Enterprise, it’s shifting to a slightly different business approach. But if history is any guide, it will make sure to reward unitholders along the way.
Strong options for high yields
Enterprise is one of the largest, and most conservative, midstream partnerships. The price decline that’s pushed its yield over 6%, however, should be temporary. Once it reaches its self-funding goals, distribution growth should pick up again, a move that investors will likely reward with higher unit prices. Holly Energy is a riskier high-yield option. It is working to reduce its cost of capital as it faces a less certain growth outlook. With a long history of rewarding investors, though, more aggressive investors might want to give this 8.7% yielder the benefit of the doubt as it seeks out new ways to grow.
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