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Phillips 66 Partners is One Heck of an MLP

Aaron Levitt May 18, 2016


It’s no secret that everyone’s favorite value investor— Warren Buffett— is a sucker for cash flows. He just loves them. And that could explain why he keeps plowing big time bucks into refining and midstream giant Phillips 66 (PSX ) . Phillips 66 has them in spades. Through the first three months of the year, Buffett and Berkshire (BRK-A ) added an additional 20 million shares of PSX.

But maybe BRK and Buffett should have added units in Phillips 66’s MLP- Phillips 66 Partners (PSXP ) instead.

In just a short time, PSXP is emerging as one of the best MLPs around as it takes advantage of its great sponsor/drop-down relationship. That means that the cash flows keep on coming at the MLP.

For dividend seekers, following Buffett’s lead— sort of— could be in order.


Drop-Downs Are Key


One of the key things about MLPs is just how they work with regards to drop-down transactions. The real basics are that sponsoring firms— in this case PSX— will place various assets inside the tax-advantaged structure by selling those assets to the MLP. So PSX will sell a pipeline to PSXP. Those sales are often done at advantageous and instantaneously accreditive rates. Meaning they instantly produce cash flows and boost distributions. Sponsoring firms benefit from those cash flows through their general partnership claims and ownership of the majority of the MLP units.

So far, the drop-down relationship has been a boon for PSXP and PSX. Let’s not forget that Phillips 66 was originally oil giant ConocoPhillips (COP ) refining arm. As one of the largest oil companies the U.S., Conoco had a lot of midstream assets that went with Phillips when they spilt up. PSX continues to add more and more of these assets into PSXP. The latest deal was for a cool $775 million and added fractionation plant, a salt cavern storage facilities and a pipeline to PSXP’s mix.

Again, the relationship works to Philips 66 benefit. The vast bulk of PSXP’s assets are under long term, fee-based contracts with PSX. It owns the pipelines and terminals that move crude oil into PSX’s refiners and the pipelines and terminals that move gasoline, jet fuel and other products out.


Steadily Rising DCF


The real benefit for PSXP is that those fee-based contracts with pretty much steady volumes continue to work their magic on the midstream MLP’s cash flows.

As PSX has added more assets to PSXP, the MLP has seen steadily rising cash flow growth across it portfolio of midstream assets. Just looking at the year-over-year number for last quarter, PSXP has managed to see distributable cash flows (DCF) jump by more than 50%. That’s pretty impressive considering that the MLP only IPO’d at the tail-end of 2013.

And that amount should continue to rise as PSX drops down more assets into PSXP.

Looking at what PSX still owns in terms of midstream assets is quite staggering. The firm has already announced that it will keep moving these assets over to PSXP in chunks. However, those huge drop-down potential doesn’t take into account organic and new projects that PSXP is a part of. PSXP announced that it organic growth plan for 2016 includes $314 million worth of spending on three new pipelines. That includes a joint venture with midstream giants Energy Transfer Partners, L.P. (ETP ) and Sunoco Logistics Partners L.P. (SLP ). Part of which started service in April.
Again these assets— both new and via drop-downs— will only continue to boost PSXP’s cash flows further.


Translates Into BIG Distributions For Investors


Already in its short lifespan, PSXP has been a dividend growth champion. In the 11 quarters since its IPO, Phillips 66 Partners has managed to grow its payout by a 39% compound annual growth rate. More importantly, its coverage ratio continues to rise. Today, cash flows cover its payout by more than 1.29x when looking at 12 month DCF rate. Simply put, for every $100 PSXP need to pay unit holders, it was making $129. That means, there’s still room to raise its 3.61% dividend before adding any additional boosts via new/drop-down projects.

This means, PSXP should have no trouble delivering on its promise of five-year annual distribution growth-rate of 30% through 2018. Given the huge back-log of potential drop-downs and organic projects still waiting to completed, I’d say that 30% is a on the low side.


The Bottom Line


Warren Buffett loves Phillips 66 and you should too. But perhaps, you should love its MLP- Phillips 66 Partners as well. The MLP has the goods to keep growing is cash flows and distributions further into the future.

Disclosure: Author is Long PSX and PSXP.

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