Profit From Rapid Dividend Growth With New IPO: Valero Energy Partners

| About: Valero Energy (VLP)

Valero Energy Corp. (NYSE:VLO) has taken a page from the "raising equity book" directly from competitor Phillips 66 (NYSE:PSX) with the recent IPO of Valero Energy Partners LP (NYSE:VLP). The structure of Valero Energy Partners is very similar to that of Phillips 66 Partners (NYSE:PSXP), which was launched in July 2013. The availability of two very comparable midstream MLPs backed by the two major independent refining companies in the U.S. promises some very attractive returns for investors in either of these two publicly traded partnerships.

Note: MLP companies such as Valero Energy Partners have units and pay distributions. The words stock, shares and dividends may be used here with the understanding that the rules of MLP units apply including the tax consequences of investing in MLP units.

Cash Hoard and Assets to Buy Galore

The Valero Energy Partners IPO on December 12 resulted in the investing public holding 29.4% of the VLP units and Valero Energy retaining the remaining 70.6%, which includes the 2% general partnership interest. The approximate $350 million raised by the IPO went straight into the partnership bank account. That money plus a new $300 million line of credit gives Valero Energy Partners the capital it needs to start growing the business ASAP.

Valero Energy dropped down crude and refined products transport and storage assets associated with 3 of the company's 16 refineries into the new MLP. These assets are projected to provide enough distributable cash flow to cover the minimum guaranteed dividend through 2014. The partnership also gets a 5-year right of first offer on 6 additional midstream assets associated with Valero refineries.

The initial assets and right to first offer assets are just a limited portion of the holdings that Valero Energy owns which could at some point end up with the limited partnership company. This paragraph out of the IPO prospectus gives an overview of these additional, potential drop downs:

Valero has a substantial and growing portfolio of transportation and logistics assets. In addition to our initial assets and our right of first offer assets, Valero has approximately 65 miles of crude oil pipelines, 1,042 miles of refined petroleum products pipelines, 40 million barrels of crude oil and feedstock tankage, 69 million barrels of refined petroleum products tankage, 50 marine docks, 135 truck rack bays at 35 locations and 1,536 railcars. Valero's rail logistics assets also include rail facilities at its McKee, St. Charles and Quebec City refineries and an ethanol truck transloading facility in Fontana, California. Additionally, Valero is in the process of obtaining regulatory approval for the construction of a rail facility at its refinery in Benicia, California that we expect Valero to complete in 2015. Over the past five years, Valero has invested approximately $1.4 billion on transportation and logistics expansion projects. In addition, Valero anticipates spending approximately $1.3 billion through 2015 on transportation and logistics expansion projects, substantially all of which are intended to increase access to cost-advantaged North American crude oil.

The point is that Valero Energy already owns and will be developing assets to provide years worth of acquisition and distribution growth for Valero Energy Partners.

Mirror, Mirror On the Wall

My scan through the Valero Energy Partners prospectus was like deja-vu all over again. The initial distribution amount and incentive distribution rights schedule are a match for the distribution structure set up for Phillips 66 Partners. The initial quarterly distribution for VLP is set at $0.215 for an annual total of $0.85. The partnership starts to paid IDRs at 15% of the added distribution amount when the dividend exceeds $0.9775 per year, the 25% IDR rate kicks in at a$1.0625 annual rate and when the annual rate goes above $1.275 - 50% greater than the initial dividend - the general partner will receive 50% of the additional cash paid as distributions. This IDR structure is the same as I outlined in my IPO article on Phillips 66 Partners.

Share Price Increase Potential

Phillips 66 Partners set a $23 per unit IPO price and the share value shot up close to $30 on the first day of trading. Now half-a-year later, with just one partial quarterly dividend paid, PSXP is trading at $36.64.

Valero Energy Partners set the same $23 IPO price and the shares traded at about $28.50 on Day One. Currently VLP sits just under $30.

PSXP moved strongly above the $30 mark after the initial earnings conference call for Q3 of 2013 in November. On the call, management stated a goal of 20% distribution growth for the first several years. Investors who jumped in at the time of my earnings follow-up article have seen their units increase by close to 15%.

Looking for Dividend Growth Share Price Appreciation

The Valero Energy Partners growth strategy appears to be using Phillips 66 Partners as a template. Twenty percent distribution growth should produce similar gains in the VLP unit price. Of course, Valero Energy Partners may go for a slower growth goal, but that does not seem likely in the light of the assets available for drop down from Valero Energy. The simple investment strategy would be to own units of both VLP and PSXP to ride the growth at least until the top IDR tier is hit and then re-evaluate based on the history to that point.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.