Income investors should look to the midstream energy MLPs, because they are a haven for dividends. Midstream companies operate in the processing and transportation of oil and gas, through pipelines and storage terminals. These companies have a steadier business model than others in the energy sector, such as exploration and production companies, which are reliant on the underlying commodity prices. That is because midstream firms operate mostly under “take-or-pay” contracts with their customers. Midstream companies receive cash flow based on the volumes of materials stored and transported through their asset networks, even when commodity prices decline.
This has proven to be a huge advantage over the past year. As the price of oil and gas fell — WTI crude is at roughly half the 2014 peak level — midstream MLPs held up relatively well in comparison with their upstream peers. A prime example of a well-run midstream MLP is Phillips 66 Partners LP (PSXP ). Phillips 66 Partners began trading on July 23, 2013, and it saw huge demand when it held its initial public offering. The units had an IPO price of $23 and quickly surged 30% to nearly $30 per unit on the first day of trading. Since then, Phillips 66 Partners has continued to reward investors with reliable cash flow and growing dividends.
A Unique MLP
Headquartered in Houston, Texas, Phillips 66 Partners is a growth-oriented master limited partnership formed by Phillips 66 to own, operate, develop, and acquire primarily fee-based crude oil, refined petroleum product, and natural gas liquids (NGL) pipelines and terminals. Its stable cash flow has allowed the stock to perform much better than the broader energy sector over the past year.
Phillips 66 Partners traces its roots to ConocoPhillips (COP ), the giant independent oil and gas producer. Several years ago, ConocoPhillips was an integrated company, meaning it had a midstream transportation business and a downstream refining business, in addition to its large upstream exploration and production unit. The company decided to break itself up into separate, publicly held entities. This led to the breakup of the company and the spin-off of Phillips 66 Partners and Phillips 66 (PSX ).
Phillips 66 Partners presents an interesting story, as it’s a self-described “growth-oriented” MLP, meaning its managerial and operational focus is on growth. Not only does Phillips 66 Partners have an above-average yield of 3.8%, it also grows its distributions by a high rate each year. The company has set a forecast for 30% compound annual distribution growth through 2018. This is a very aggressive target, but judging by Phillips 66 Partners’ underlying fundamental strength, it is entirely achievable. Last year, the company generated $228 million of distributable cash flow, which was up 78% from the previous year. It followed this up with another 53% growth in distributable cash flow in the first quarter of 2016. The major contributors to these high growth rates were increased volumes and cash flow due to acquisitions.
It is not often that a midstream pipeline operator calls itself a growth company. However, that is not to say that income investors will be dissatisfied by buying Phillips 66 Partners — far from it. Investors have enjoyed rapid growth in cash flow and distributions, while still collecting an above-average yield.
Distribution Growth and Outlook
Phillips 66 Partners has done an excellent job growing cash flow and distributions. On July 20, Phillips 66 Partners’ Board of Directors of its general partner declared a second-quarter 2016 cash distribution of $0.505 per unit. This represents a 26% increase from the same second-quarter distribution last year. This is the 11th consecutive quarterly distribution increase since Phillips 66 Partners’ initial public offering. The new quarterly distribution is payable Aug. 12 to unitholders of record as of Aug. 3.
Continued growth of distributions will rely on further expansion of its business operations. Fortunately, Phillips 66 Partners has an extensive lineup of new projects to fuel future growth. Its Sacagawea Pipeline is expected to start up in the third quarter this year. Separately, on March 1, Phillips 66 Partners acquired a 25% stake in Phillips 66 Sweeny Frac LLC. The price tag of $236 million will again be funded mostly by unit offerings. The acquisition included the newly constructed natural gas liquids fractionator located in Texas, as well as the Clemens Caverns, a newly constructed underground salt dome NGL storage facility. Phillips 66 Partners entered into 10-year agreements with Phillips 66, which also included a minimum volume commitment.
The key takeaway is that Phillips 66 Partners has plenty of growth potential going forward, which will help the company continue to raise its distribution. Assuming 30% distribution growth each year through 2018 and 10% distribution growth thereafter, Phillips 66 Partners will generate significant income for investors. By 2020, its dividend is projected to be more than double its current level.
The Bottom Line
In a low interest rate environment, high yield is hard to find. This is especially true when it comes to high yields that are sustainable over the long term. But income investors should take a look at Phillips 66 Partners, a pipeline MLP with a long runway of growth ahead of it. Phillips 66 Partners features among the highest rates of distribution growth one will find in the entire MLP universe.