Drop-Down Transactions To Drive Growth For MPLX

| About: MPLX LP (MPLX)
This article is now exclusive for PRO subscribers.

In the past, investing in fledgling publicly traded partnerships has proved to be a winning proposition and an opportunity to find value when the market bids stock prices up to frothy levels. However, investors should be forewarned selectivity is critical to this strategy's success.

Master limited partnerships (MLPs) often grow their distributions at an accelerated rate in their first two years as a publicly traded entity. These rising quarterly payouts, coupled with a raft of research reports from Wall Street analysts, tend to attract investors' attention and drive the stock price higher.

At the same time, brokerage and financial websites often misreport recently listed MLPs' yield until the firm has paid a full year's worth of distributions. This quirk gives investors an opportunity to buy these stocks before the herd realizes how much the units yield.

Energy & Income Advisor covers every energy-related publicly traded partnership, a mission that requires us to scrutinize and assess every initial public offering (IPO) in the space. To this end, we recently analyzed the nontraditional MLPs that debuted on the New York Stock Exchange this fall. (See "Initial Public Offerings: Catching up with the Master Limited Partnership Class of 2012.")

In this article, we are continuing our review of the most recent midstream partnerships to go public. Today, we turn our attention to MPLX LP (NYSE:MPLX).

A spin-off from refining giant Marathon Petroleum Corp. (NYSE:MPC), MPLX LP went public at the end of October. The underwriters had planned an IPO of 15 million units at a price of between $19 and $21 per unit, but upsized the offering to 17.3 million units at $22 apiece. In subsequent trading sessions, the stock has rallied to more than $30 per unit.

MPLX owns a stake in 962 miles of crude-oil pipelines and 1819 miles of refined-product pipelines spread across seven Midwestern states and in Texas and Louisiana. The firm also owns a crude-oil barge loading dock on the Mississippi River in Illinois, oil and refined-product storage facilities in Illinois and Indiana, and a butane storage cavern in West Virginia.

These pipelines and storage facilities represent some of the lowest-risk assets in the midstream segment. MPLX has five- and 10-year contracts with Marathon Petroleum, agreements that include commitments for fixed prices and volumes on its pipelines and storage assets. These deals ensure that MPLX receives a minimum fee regardless of whether Marathon Petroleum utilizes its allotted capacity, while the contract terms include potential tariff increases based on the U.S. inflation rate and additional volume-related fees.

In total, roughly three-quarters of the MLP's total revenue is covered by minimum service commitments, limiting the partnership's exposure to fluctuations in commodity prices and economic growth. With an asset base that's concentrated in the Midwest, Marathon Petroleum boasts the ideal geographic footprint to take advantage of favorable basis differentials, a topic we tackled in Mind the Differentials. These superior economics should ensure that MPLX's sponsor runs its refineries at high utilization rates, supporting robust throughput on the fledgling publicly traded partnership's assets.

Moreover, drop-down transactions from Marathon Petroleum will likely drive MPLX's future distribution growth. The partnership's sponsor owns 5,000 miles worth of oil and product pipelines, three liquefied-petroleum-gas storage terminals in West Virginia, 62 refined-product terminals, a fleet of crude-oil barges and a minority stake in the pipelines operated by MPLX.

All these assets would fit perfectly MPLX's portfolio. We expect Marathon Petroleum to gradually monetize these assets by selling them to the partnership over the next three to five years, likely with transaction terms that are immediately accretive to the MLP's distributable cash flow.

With an almost 50% equity stake in the MPLX and 100% ownership of its general partner (GP), Marathon Petroleum has ample incentive to pursue strategies that will enable the partnership to grow its quarterly distribution. Through its GP interest, Marathon Petroleum will begin to receive incentive distributions once MPLX's regular quarterly payout exceeds $0.301875 per unit. We explained incentive distribution rights at length in the Nov. 15, 2012, installment of Energy Investing Weekly, "MLP Basics: Incentive Distribution Rights Explained."

MPLX's prospectus sets a minimum quarterly distribution of $0.2625 per unit. If MPLX fails to disburse this amount in a given three-month period, it must pay any arrearage in a future quarter.

In addition, some of Marathon Petroleum's equity stake in MPLX is in the form of subordinated units that only receive distributions when the common unitholders have been paid in full. Given the safety of MPLX's asset base, its subordinated unit structure and long-term minimum volume commitments, the MLP should have no problem meeting its minimum quarterly payout.

In fact, planned expansions to its existing asset base, coupled with inflation-indexed tariff increases, should enable MPLX to grow its distribution modestly in coming years. With a steady stream of drop-down transactions, the MLP's payout could increase at an average annual pace of more than 20% over the next three years-among the highest and most visible growth rates of any MLP in our coverage universe.

Based on its minimum quarterly distribution of $0.2625 per unit, MPLX's common units currently yield 3.5%. We expect the publicly traded partnership to disburse between $1.25 per unit and $1.30 per unit in 2013, equivalent to a distribution yield of 4.2%. That's in line with the yield offered by Western Gas Partners LP (NYSE:WES), another MLP with a robust pipeline of potential drop-down transactions and a supportive general partner.

Disclosure: I am long WES, MPC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.