MPLX LP's Strong 6.4% Yield Is Set To Grow

Summary

• MPLX LP's 6.4% yield is well covered and set to grow, a boon for Marathon Petroleum Corporation as well.
• An eye on major expansions in Appalachia in light of recently formed JV.
• Completion of major dropdown from from Marathon Petroleum supports strong near term growth at MPLX LP.
• Purchase of pipeline from third party created organic growth opportunity MPLX LP quickly jumped on.
• Debt load a concern.

MPLX LP (NYSE:NYSE:MPLX) is a major midstream player along the Gulf Coast and Appalachia region. Gathering, processing, marketing, and storing dry gas and NGLs produced in the Marcellus and Utica shale plays is a key part of MPLX LP's business. Let's take a lot at how this ~6.4% yield is doing in light of the ongoing turbulence in the oil & gas space.

This article touches on Marathon Petroleum Corporation (NYSE:MPC) as MPLX LP is its midstream spin off. Marathon Petroleum is expecting to get $1.2 billion - $1.4 billion in annual distributions from its stake in MPLX LP after the IDR exchange.

Financials

The amount of cash that midstream master limited partnerships can pay out to their unitholders is largely determined by the MLP's distributable cash flow streams. MPLX grew its DCF streams from $236 million in Q1 2016 to $354 million in Q1 2017. By pushing its distribution coverage ratio (DCF dividend by payouts to unitholders) up to 1.29X in Q1 2017 from 1.18X a year earlier, MPLX was able to increase its distribution per unit by 6.9% y-o-y.

On a quarter-over-quarter basis, MPLX's coverage ratio rose from 1.25X in Q4 2016 to 1.29X in Q1 as its DCF streams climbed from $318 million to $354 million. MPLX increased its distribution from $0.52 to $0.54 q-o-q.

MPLX has a well covered distribution with room to support additional payout growth. A coverage ratio over 1.10X is nice, 1.15X ideal, and anything over 1.20X means there is room to grow. Fiscal discipline is good to see, as DCF growth outpaced payout growth implying a cautious strategy in light of the volatile pricing environment.

By the end of Q1, MPLX had $811 million in current assets stacked against $712 million in current liabilities and $6.65 billion in long term debt. While its near term liquidity situation is favorable, MPLX has taken on a fair amount of debt to fund its various expansions. MPLX retains an undrawn $2 billion revolving credit line due 2020, providing ample access to liquidity.

It isn't until 2019 that its $250 million term loan matures, with no major maturities after that until 2023. As it sports a fairly strong financial position, MPLX has been able to justify its M&A activity.

M&A

Keep in mind that midstream MLPs often issue out units, the rough equivalent of shares, to fund the purchase of assets from either its parent company (referred to as dropdowns) or third parties. The idea is that the seller converts its income producing asset into a large pile of cash while the buyer gets a DCF producing asset where the DCF exceeds the cost of capital to acquire it, with the tax advantages of being an MLP playing a big role.

At the beginning of March, MPLX completed the purchase of just over $2 billion in assets from its parent company Marathon Petroleum. In return for a series of terminal, pipeline, and storage assets, MPLX is giving Marathon Petroleum $504 million in MPLX equity and $1.5 billion in cash. Those assets are expected to generate $250 million in EBITDA on an annualized basis and Q2 is the first full quarter since the transaction.

MPLX also completed the purchase of Ozark Pipeline from a subsidiary of Enbridge Energy Partners LP (NYSE:EEP) on March 1. For $220 million, MPLX added a 230,000 bpd oil pipeline that runs from Cushing, Oklahoma, to Wood River, Illinois. An expansion project will increase that to 345,000 bpd by Q2 2018.

With $18.25 billion in total assets at the end of Q1, MPLX's debt load starts to look a lot more manageable. Proceeds raised from capital markets are used to expand MPLX's asset base while DCF streams generated from those assets fund growth capex and distributions.

Growth overview

As I said at the beginning of this article, MPLX LP is a big player in the Marcellus and Utica plays. The firm wants to add 160,000 bpd of fractionation (used to separate NGLs from gas output streams) capacity and 1.6 Bcf/d of gas processing capacity to the Appalachian region by the end of next year.

In the event additional pipeline takeaway options are built in the region, which appears to be the case, production growth out of those two plays should continue to be very strong for years to come. That production will be a combination of dry gas, which is currently constrained by limited takeaway options, and 'wet gas' in need of fractionation capacity.

Natural gas liquid fractionators separate the liquids component from the production stream, such as ethane, butane, propane, and natural gasoline. Without that infrastructure upstream firms can't effectively target 'wet gas' plays in the region, namely the Utica, as upstream players would get a much lower price for their production.

Example of planned growth trajectory

One great example of this grand expansion plan is the 50/50 JV MPLX's wholly owned subsidiary MarkWest entered into with Antero Midstream Partners LP (NYSE:AM), the MLP spinoff of Antero Resources Corp (NYSE:AR). The venture sees three additional gas processing plants being added to the Sherwood Complex in West Virginia, boosting its total processing capacity by 600 MMcf/d.

During the first quarter of this year, the Sherwood VII processing plant with 200 MMcf/d of additional capacity came online. This is on top of 1.2 Bcf/d of existing capacity at the Sherwood Complex which MPLX owns the entirely of. In Q4 2017 and Q1 2018, another two very similar plants should come online.

If all goes well the JV indicated another eight processing facilities could be needed to support upstream operations. Part of this deal included increasing the amount of acreage dedicated to MarkWest, owned by MPLX, by 167,000 gross acres to 360,000 gross acres as Antero released that acreage to support the newly formed venture.

There is also room for the JV to expand the fractionation capacity at MPLX's Hopedale Complex. Another part of the agreement included the venture investing in 20,000 bpd of the Hopedale's 180,000 bpd of existing fractionation capacity. If a strong reason came up to expand the complex's capacity, this JV would most likely lead the way splitting the costs evenly.

Final thoughts

A combination of organic growth projects and M&A activity will continue to propel MPLX LP's DCF streams higher, while a high coverage ratio ensures unitholders get to keep pocketing that ~6.4% yield.

Investors should be warned that a large part of MPLX LP's growth story depends on new gas pipelines coming online in Appalachia, and the regulatory risk (particularly on the state and local level) remains very real. If upstream players can't find buyers for larger production streams they won't grow, removing the need for MPLX LP to expand and eliminating that growth opportunity.

Assuming at least some of those planned pipeline expansions are completed successfully, MPLX LP's future looks quite bright with growth opportunities elsewhere providing additional upside. Marathon Petroleum Corporation should be pleased its midstream unit is doing well, all things considered.

Analyst’s Disclosure: I/we 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.