MLPs: It's All About The Distribution Growth Rate

by: Tyson Halsey, CFA

Income Growth Advisors sold Calumet Specialty Products, LP (NASDAQ:CLMT) and bought Targa Resources Corp. (NYSE:TRGP) for its MLP clients

Calumet Specialty Products LP is a company that we have owned for years for our clients. They had had some operating difficulties, did not hedge effectively, and declined from 55 and then to below 10 during the 2008-9 market crash. The company has recovered, rebounded, and closed Friday, December 9, 2011 at $19.38 per share. CLMT trades with a yield of 10% based on a distribution on the trailing twelve months of $1.94/unit. The yield is up from $1.825/unit in 2010 — which is a respectable 6.3% distribution growth rate. Generally, a good distribution rate plus a good distribution yield, is the key to successful MLP investing.

However, we believe the distribution growth rate at CLMT will moderate to the 2-3% level for the next year or more. Further, with the Superior Wisconsin acquisition from Murphy Oil (NYSE:MUR), CLMT has some integration risks that argue for a less positive view on the company. We don’t dislike Calumet Specialty Products, LP -- it is a good company -- and don’t think the recent inside purchase by Director Fred Fehsenfeld Jr. is misguided. We just believe in “skating to where the puck will be” as Warren Buffet has cited as Wayne Gretsky’s key to success. We believe the lack of expected distribution growth combined with the Superior Wisconsin acquisition risk signals one of those times, where we will sell a position and reinvest our clients’ assets where we believe there is more distribution growth potential. We would be buyers on dips of Calumet Specialty Products, LP. At this moment in time, we see the company losing momentum and prefer allocating money elsewhere.


On December 1st, 2011, Targa Natural Resource Partners LP (NYSE:NGLS), issued guidance for a distribution increase of 10-15%. NGLS’s general partner Targa Resources Corp. also raised its dividend guidance by an impressive 30-40%. NGLS recently guided for continue acceleration in fractionation volumes. Targa’s natural gas liquids volumes, their exceptional shale properties, and their positioning allow them to leverage this important MLP sub-sector. NGLS is currently yielding 6.1% and distribution growth is projected to be 10-15% next year and over 10% for the next few years. They have had high coverage ratios which give them that flexibility, but it is their capital expansion that will drive the higher distributions benefitting in part from their increased natural gas liquids and fractionation output.

We have reinvested the proceeds of CLMT and purchased Targa Resources Corp. We like Targa Natural Resources Partners, LP, though we did not increase our client’s holdings in early December. One MLP subsector (or theme) we like is those companies with exposure to natural gas liquids. We know that the country is awash in a massive supply of natural gas and the commodity price is on the floor for the foreseeable future. However, our great natural gas boom is producing important growth in natural gas liquids. What is important here is that these natural gas liquids trade with oil prices which are in a secular bull market. The economics are simple. The cost of developing natural gas liquids is low relative but the price that these liquids can be sold for benefits from the upward bias to natural gas liquids prices. This gives a unique margin expansion opportunity for companies which produce meaningful amounts of natural gas liquids. NGLS is the symbol for Targa Natural Resource Partners, LP and, as its ticker symbol itself implies, is an acronym for natural gas liquids.

Another MLP subsector and theme we favor is MLP General Partners (GPs). In general, we believe that longer term, the GP is in a superior return position relative to the Limited Partner unit. There are reasons and times to own LPs and reasons and times to own GPs, but that is another article. As of this writing, we have added to Targa Resources Corp. and its addition to our portfolios has added diversity, since we own NGLS, increased exposure to natural gas liquids, added a new MLP GP, and added to the dividend distribution profile of our portfolios.


I have been investing in Master Limited Partnership MLP separate accounts for over 10 years, and this asset class is an exceptional winner. Experience has shown that investing in those MLPs which are able to grow their distributions effectively is the key fundamental factor that has produced the greatest returns within this investment sector.

While we expect continued outperformance in MLPs in the future, it will not be as robust as it has been in the past. Growth in distributions will be slower due to more conservative balance sheets that are a result of the 2008-2009 market collapse that squeezed some leveraged MLPs, which led to more conservative use of debt sector wide. Relative to stocks over the next five to ten years, MLPs, we believe, will outperform the S&P 500 on a total return basis while producing a much needed income source for retirement and in the “great recession.” The key to superior performance in the MLP sector is the company’s growth, the distribution growth, and the yield. Future income and future income growth will decide whether you have a bond alternative or an outperforming MLP. We recommend the latter within the sector and relative to equities in general.

Source: Yahoo Finance

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. On December 2, 2011 we sold for MLP accounts CLMT and bought TRGP. We are a Registered Investment Advisor which manage MLP and dividend growth portfolios.

Disclaimer: The information expressed in this note and on our website is based upon the interpretation of available data. The data being presented was obtained or derived from sources believed to be accurate, but Tyson Halsey, CFA and Income Growth Advisors, LLC cannot and does not guarantee the accuracy of these sources which may be incomplete and/or condensed. The data and information presented is provided for informational purposes only, and is not offered as a basis for trading in securities nor is it offered for that purpose. Readers and potential investors should conduct their own independent investigation before making any investment or business decisions with respect to Calumet Specialty Products, LP, Targa Natural Resources LP, Targa Resources Corp. or other securities presented on this website. Nothing contained herein should be construed as a recommendation to buy or sell any securities.