Published January 8th, 2017 by Bob Ciura
The collapse in oil and gas prices from 2014-2016 caused a great deal of turmoil in the energy sector. The hardest-hit companies were those engaged in exploration and production. These companies need a high commodity price to generate cash flow.
By contrast, midstream companies like Holly Energy Partners (HEP) saw a much milder downturn. Holly Energy does not explore and drill for oil; instead, it stores and transports it through pipelines and terminals.
The midstream business model insulates companies like Holly Energy from steep declines in oil and gas prices. Investors have been rewarded with consistent distribution increases for many years.
Holly Energy has increased its distribution for 12 years in a row, including a recent 7.2% year-over-year hike.
This makes it a Dividend Achiever, which are stocks that have increased dividends for 10 consecutive years or more.
You can see the entire list of all 272 Dividend Achievers here.
In fact, Holly Energy has raised its distribution each quarter since the company’s initial public offering in 2004. This makes 48 quarters in a row of uninterrupted increases.
Today, Holly Energy has a very high yield of 7.4%.
This article will discuss how Holly Energy managed to thrive, even during one of the worst downturns for the oil and gas industry in years.
Holly Energy is structured as a Master Limited Partnership, or MLP. Holly Frontier Corp. (HFC) owns 37% of Holly Energy Partners, and has 2% General Partner Interest and Incentive Distribution Rights.
Combined, Holly Energy and Holly Frontier have an extensive asset network that stretches across the U.S.
Source: December 2016 Investor Presentation, page 4
In all, it has 3,400 miles of oil pipelines that have total capacity of 14 million barrels of oil. Holly Energy also owns 8 terminals and 7 loading rack facilities in 10 western and mid-continent states.
The reason why Holly has continued to increase its distribution each quarter is because of its highly stable business model. The company’s revenues are 100% fee based, which means Holly’s assets have only limited commodity price risk.
This has resulted in strong growth since the company’s inception.
Source: December 2016 Investor Presentation, page 8
Business conditions remained healthy throughout 2016, even with low oil prices. Holly Energy’s revenue and distributable cash flow increased 10.6% and 11.7%, respectively, over the first three quarters of the year.
Distributable cash flow is a non-GAAP metric frequently utilized by MLPs. It is similar to EBITDA. It provides a perspective of the operating performance of the company’s assets and the cash generated by the underlying business.
Also of note is that Holly Energy’s revenue and DCF growth exceeded growth in units outstanding. The company’s units outstanding increased by only 0.4% through the first nine months of 2016.
Moving forward, Holly Energy has a three-pronged plan for growth:
- Organic Growth
Source: December 2016 Investor Presentation, page 9
First, Holly Energy has the good fortune of operating in some of the premier oil-producing fields in the U.S.
One of which is the Permian Basin, which produces over 1 million barrels of oil per day. Holly Energy owns and operates more than 800 miles of crude pipelines in the Permian Basin.
In all, Holly Energy has $400-$450 million in projects that are either completed or scheduled. Collectively, this investment is expected to result in approximately $100 million in annual EBITDA growth starting next year.
Second, through its partnership with Holly Frontier, Holly Energy stands to benefit from dropdowns. Two projects in particular are at the company’s Woods Cross and El Dorado refineries. These are expected to generate annual EBITDA of at least $32 million and $6 million, respectively.
Holly Energy will take no commodity risk from either project. And, both Woods Cross and El Dorado are contracted for 15 years.
Lastly, Holly Energy can use its financial flexibility to make strategic bolt-on acquisitions.
Its recent acquisitions include the purchase of 6 oil tanks from a subsidiary of Plains All American (PAA), which are expected to contribute $6.1 million of annual revenue. In addition, Holly Energy purchased the 87-mile, approximately 80,000 barrel-per-day Cheyenne pipeline.
Holly Energy has a 50% interest in the pipeline, which is expected to generate $5-$7 million in annual EBITDA.
Growth through organic projects, dropdowns, and acquisitions should allow Holly Energy to keep pumping out its hefty distributions for many years.
Importantly, Holly Energy maintains a disciplined balance sheet. It has an investment-grade credit and significant financial liquidity.
This liquidity includes a $1.2 billion credit revolver, $820 million of which is currently available. In addition, the company has a debt-to-EBIDTA ratio of 4.0, which is within a normal range for an MLP.
Considering the cash generating abilities of the core business and its conservatively-capitalized balance sheet, Holly Energy’s distribution appears secure.
Holly Energy has grown its dividend at impressive rates since the company’s inception.
Source: December 2016 Investor Presentation, page 7
Going forward, the company has a stated goal of 8% distribution growth each year. This is an ambitious growth rate for a high-yield MLP, but it appears achievable.
For example, the company has a healthy payout ratio. In the past four quarters, Holly Energy earned $3.63 per unit of distributable cash flow.
After its recent distribution increase, Holly Energy’s forward annualized distribution payout is $2.38 per unit. This comes out to a healthy 65% payout ratio, which leaves room for future distribution hikes.
Assuming the company meets its target, investors will generate significant income over time. The combination of a 7.4% yield and 8% distribution growth would quickly elevate an investor’s yield on cost.
For example, under this scenario, yield on cost would rise to 11% in just five years. This means investors would be earning 11% of their original investment, in annual dividend income.
Investors are right to be wary of MLPs these days, given the carnage that swept through the oil and gas industry over the past two years.
The key takeaway from all the MLPs that cut or suspended their distributions in that time, is that it is best to focus on the companies with strong assets and modest debt levels.
Holly Energy fits the bill. Its distribution yield is very high, at nearly four times greater than the average dividend yield in the S&P 500.
Fortunately, its distribution appears secure, and even has room for growth up ahead. As a result, Holly Energy is an attractive MLP for high levels of income.