As I research some of the fast dividend growth MLP stocks, I am often struck by how quickly these companies grew during their first few years of existence, before the readily available growth opportunities had been exploited and continued growth gets tougher. The IPO of Phillips 66 Partners (NYSE:PSXP) presents what I believe is one of these opportunities to get in early and ride some attractive dividend and unit price gains over the next few years.
Note: MLP companies such as Natural Resources Partners LP 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 Nuts and Bolts and Bucks
The July 23, 2013 IPO consisted of 17.25 million units - assuming the full option to underwriters was taken - with an IPO price of $23 per unit. The publicly traded units account for 24.5% of the common units. Phillip 66 (NYSE:PSX) retains the balance of the common units and the 2% general partner interest including incentive distribution rights. More details of the offering are in the SEC Form S-1/A.
The assets dropped into the partnership consist of the product terminals, crude and refined product pipelines, and barge and ship docks at three of the Phillips 66 refineries. For reference, the company owns 15 refineries.
The minimum distribution has been set at $0.2125 per unit quarterly, or $$.85 per year. Incentive distribution rights of 15% on excess distributions kick in at a $0.9775 annual distribution rate, the 25% tier comes at $1.0625, and the maximum 50% IDR starts at annual distributions of $1.275. At the time of the IPO, 49% of the total common units are subordinated, which means if the minimum $0.2125 quarterly payout is not made on the non-subordinated units, distributions will be suspended on the subordinated ones until the minimum dividends and any arrears have been paid to the public unit holders. Phillips 66 holds all of the subordinated units in its 73% of the company.
For the existing number of units, the cash flow required to pay the minimum dividend is $61 million per year. Pro-rata distribution cash flow for the 12 months ending on March 31 would have been about $67 million, and the forecast for the year ending June 30, 2014 is a similar amount of DCF.
Potential For Growth
The intention of the Phillips 66 Partners spin-off is to use the MLP business structure to grow this portion of the Phillips 66 business. It appears that the new company received just a fraction of the assets the mothership Phillips 66 could eventually drop down to the MLP. To start with, Partners has first rights to purchase the one-third interest in the two NGL pipelines that Phillips 66 owns jointly with Spectra Energy (NYSE:SE) and DCP Midstream LLC.
The net proceeds of the IPO plus the general partner contributions for its share of the PSXP units provides the initial capital to pay for future expansion - all of the cash is available to Phillips 66 Partners. With this money, Phillips 66 Partners starts out with about $500 million of dry powder cash and a $250 million revolving line of credit. As with all MLP companies, future asset purchases or development would be funded with a combination of debt and the issue of new units. The financial strength of Phillips 66 as the general partner should provide the Partners with a competitive capital raising advantage.
From history, an MLP spin-off from a major energy company sets up the partnership with an unfair advantage for growth. For a model of the investment potential of Phillips 66 Partners, take a look at Tesoro Logistics LP (TLLP). Since this MLP was spun-off by refiner Tesoro Corp. (TSO) a little over 2 years ago, the TLLP share price has more than doubled. Over the last four quarters through Q1 of 2013, the TLLP dividend was increased by 30%. Looking further back in history, when Sunoco Logistics Partners LP (NYSE:SXL) IPO'd out of Sunoco in 2002 that stock doubled in value over the next two years.
The potential and almost certainty for Phillips 66 Partners to receive additional drop-down assets from Phillips 66 at prices that will be immediately accretive to cash flow makes PSXP seem like as close to a sure bet double in the next two to three years as you can find in the stock market.
As I write this on the first day of public trading for PSXP, the share price has been pushed up to $30 from the $23 IPO value. At $30, the minimum dividend rate gives the stock a 2.8% minimum yield. However, current yield is not the goal here - growth of distributions and unit price is. It is apparent that this will be a very popular MLP, due to the Phillips 66 name. While the unit price may drop from today's run-up, consider at least a half-position now in case this is the lowest the price is ever available. If at some future point in time, the unit price does drop back close to the IPO price into the mid-$20's, pick up some more.
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.