Don't Ignore This Reliable MLP -- It's Cheap Right Now
Master limited partnerships are not like other stocks, and the metrics we use to compare an MLP to its peers differ from the metrics we use to compare regular companies. For example, instead of the traditional P/E ratio, we emphasize MLP-specific metrics like distribution coverage ratio, and today's focus: price to distributable cash flow (P/DCF). I'll use MPLX , Tesoro Logistics , and Holly Energy Partners as our three examples.
Why this metric?
Price to distributable cash flow is the MLP metric that comes closest to the P/E ratio most investors know and love. Like any good ratio, it allows you to compare MLPs on a relative basis, regardless of size.
Distributable cash flow per unit replaces earnings per unit in these relative valuations because MLPs pass through almost all of their cash to unitholders. Distributable cash flow drives distribution growth, which in turn drives unit prices. That's really what investors care about the most with MLPs, and that's why analysts and management never discuss earnings per share for their MLPs; it's all about distributable cash flow.
How the metric works
To calculate P/DCF, you take the market cap of the MLP and divide it by a full year of distributable cash flow.
Let's use MPLX as our first example. We'll use distributable cash flow numbers from the four most recent quarters. The numbers shake out like this:
Now we'll divide the partnership's market cap by $124.3 million to derive our P/DCF multiple:
The whole point of this exercise is relative valuation, so let's see how Enterprise's multiple compares to some of its peers. The DCF numbers for Tesoro Logistics and Holly Energy Partners come from the same four quarters that we used for MPLX.
It's an interesting group, and a bit surprising perhaps to see that MPLX appears grossly overvalued right now, based on this one metric. But what is the benchmark for this cash flow multiple anyway? Most investors have heard that a P/E ratio greater than 15 is high, and the further it floats above that magic number, the more overvalued the stock is. According to analysts at Morgan Stanley and Wells Fargo, the average multiple for large-cap MLPs like today's group has been between 15 and 16 times price to distributable cash flow.
By that standard, Holly Energy Partners is the only MLP here that is "cheap." This is a signal to investors to ramp up their research. For starters, Holly Energy Partners has a tremendous distribution history, increasing its payout each quarter for the last nine-and-a-half years. Distribution consistency is driven by the fact that 100% of its shipping agreements are fee-based, mitigating its exposure to commodity risk.
Despite having a rough go of it price-wise over the last 12 months, Holly Energy Partners total return for the last 10 years is north of 424%. It is a slow grower, to be sure, but it has an investment grade credit rating and is a healthy MLP, certainly worthy of further research.
Again, the P/DCF ratio is useful for relative valuations, but by no means would you want to base your entire investing thesis on this one metric alone. In that regard, it is exactly like the P/E ratio: a great place to start your search.
Add some more reliable picks to your portfolio
By now, you've heard that record oil and natural gas production is revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. That's why The Motley Fool is offering a look at three energy companies using a small IRS "loophole" to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report "The IRS Is Daring You To Make This Energy Investment." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free.
The article Don't Ignore This Reliable MLP -- It's Cheap Right Now originally appeared on Fool.com.Aimee Duffy has no position in any stocks mentioned, and neither does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.