A few days ago I wrote about Targa Resource Partners L.P. (NYSE:NGLS) as an attractive, growing distributions investment. At the time, I just mentioned the company that holds the general partner interests, Targa Resources Corp. (NYSE:TRGP) because I think this stock provides some extra, attractive features for investors. Targa Resources Corp. is more of a capital gains play, but those gains will be driven by a rapidly increasing dividend.
Note: MLP companies such as Targa Resource 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.
The L.P. General Partner Structure
With a master limited partnership business structure, there are two types of units. The shares that trade on the stock exchange are the limited partner units. Investors that own L.P. units get to participate in the financial results of the company but have no say in how the company is run or managed. The general partner units usually are a 2% stake in the whole company, but the owner of the GP units gets to make the business decisions. The GP stake of an MLP may be owned by a private company, a publicly traded corporation or another MLP.
Along with its 2% share of any distributions that are paid to MLP unit holders, the partnership agreement is often written to pay incentive distribution rights - IDRs - to the owner of the general partner stake. The IDRs typically require the payment of a larger portion of distributable cash flow to the general partner once the dividend rate paid to L.P. unit holders exceeds a certain level. The IDR schedule often has several "splits" so that as the L.P. dividend increases, the percentage split going to the G.P. as IDRs also increase. For a growing MLP company that is increasing its dividend rate and issuing more units to fund capital expansion costs, the IDRs can be very lucrative to whoever is holding the GP rights.
Targa Resources IDR Agreement
Targa Resources Corp. holds the GP and IDR rights to Targa Resource Partners plus 12.3% of the L.P. units. The general partner interests are a 2% ownership in the limited partnership and the GP is entitled to receive 2% of any distributed operating surplus cash flow. The partnership agreement requires the distribution of all surplus operating cash flow above a level of reserves detailed in the agreement. The general partner determines what amount of total cash flow should be held back to cover operating expenses and capital expenditures.
Targa Resources Corp. as the general partner also receives incentive distribution rights when the quarterly distribution per unit exceeds certain levels. Here is the current IDR split out of the S-3, shelf registration statement:
"If for any quarter we have distributed available cash from operating surplus to the common unitholders in an amount equal to the minimum quarterly distribution, then, our partnership agreement requires that we distribute any additional available cash from operating surplus for that quarter among the unitholders and the general partner in the following manner:
•first , 98% to all unitholders, pro rata, and 2% to the general partner, until each unitholder receives a total of $0.3881 per unit for that quarter (the "first target distribution");
•second , 85% to all unitholders, pro rata, and 15% to the general partner, until each unitholder receives a total of $0.4219 per unit for that quarter (the "second target distribution");
•third , 75% to all unitholders, pro rata, and 25% to the general partner, until each unitholder receives a total of $0.50625 per unit for that quarter (the "third target distribution"); and
•thereafter , 50% to all unitholders, pro rata, and 50% to the general partner."
The first quarter dividend paid by Targa Resource Partners was $0.6975 per share, putting the G.P. IDR split well into the 50% category, allowing half of all surplus operating capital generated each quarter to go to Targa Resources Corp.
Targa Resource Partners paid a $0.5575 dividend for the second quarter of 2011 and has increased the distribution every quarter since, resulting in a 25% increase in the quarterly cash dividend per unit from NGLS over 2 years. Over the same time period, The TRGP dividend grew to $0.495 from $0.2725, an 82 percent increase. The Targa Resources Corp. dividend has been growing at 3 times the rate of the Targa Resource Partners distribution increases.
The supercharged dividend growth works because Targa Resources has 42 million shares outstanding compared to 102 million for Targa Resource Partners. Since MLP companies fund growth by regularly issuing new limited partner units, the IDR cash split to the GP will increase at a faster rate with both a growing dividend for the limited partner investors and because more cash must be paid to cover the distributions on newly issued units.
My recent article, Targa Resource Partners' Balanced Business Auto-Hedges Natural Gas Prices For Steady Dividend Growth, breaks down how I believe that the Partners side of Targa is well-positioned to maintain the targeted 10% per year distribution growth. If this happens the Targa Resources Corp. will grow by 25% to 30% per year, which should pull up the share price by a similar percentage. This means an investment in TRGP has the very visible potential to double in less than 3 years. Targa Resources Corp. sports a current dividend yield of 3%.
Targa Resources Corp. is a corporation and pays regular dividends. No K-1 hassles with this MLP GP play. The general partner and L.P. holdings are the only revenue sources for TRGP, and the company does not plan to issue shares on the G.P. side to support L.P. growth.
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.