Buy The 7.7% Distribution Yield Of Holly Energy Partners Before It Drops Further

Summary

• HEP has proved one of the most resilient oil companies to the pandemic.
• Due to the steep rally of HEP, its distribution yield has decreased from 11.0% to 7.7% in about four months.
• However, investors should not dismiss the stock for this reason.
• The yield of HEP remains attractive, particularly given the distribution coverage ratio of 1.92.

About four months ago, I stated that the 11.0% distribution yield that Holly Energy Partners (NYSE:HEP) was offering back then was safe. Since then, the business outlook of the MLP has greatly improved and hence its distribution has become even safer. Even better for the unitholders, the stock has rallied 47% since my article and thus its yield has dropped to 7.7%. Nevertheless, Holly Energy Partners remains attractive and hence investors should lock in its current yield before it drops further.

Business overview

Holly Energy Partners owns essentially all the pipeline network of crude oil and refined products as well as the terminal assets that support the refining and marketing business of HollyFrontier (HFC). Among others, this asset portfolio includes storage capacity of approximately 15 million barrels of refined products and 3,400 miles of pipelines of crude oil and refined products.

Holly Energy Partners faced an unprecedented downturn last year. Due to the coronavirus crisis, the global demand for oil products plunged the most in at least 30 years, from 101.4 million barrels per day in 2019 to 92.3 million barrels per day in 2020. The U.S. refiners were greatly affected by this decrease in consumption and thus they drastically reduced their refinery utilization rates and their production of refined products. As Holly Energy Partners generates its revenues from the transportation and storage of crude oil and refined products, it was inevitably affected by the steep decrease in the production of refined products.

However, Holly Energy Partners has one of the most resilient business models in the energy sector. Nearly all its revenues are fee-based while the company has minimum-volume requirements in the contracts with its customers. These minimum-volume requirements, which force customers to execute minimum payments regardless of their actual volumes, comprise approximately 70% of the total revenue of Holly Energy Partners. As a result, Holly Energy Partners is one of the most resilient energy companies in the ongoing downturn.

The resilience of Holly Energy Partners was evident in its results. In 2020, the company reported just a 6.6% decrease in its revenues. Even better, its distributable cash flow grew 4%, from $273.4 million in 2019 to $284.0 million in 2020, primarily thanks to lower interest expense and lower operating costs. The MLP generated such strong cash flows that it was able to reduce its debt load and thus reduce its interest expense. To cut a long story short, Holly Energy Partners has proved one of the most resilient oil companies in the ongoing coronavirus crisis. To be sure, all the well-known oil majors, such as Exxon Mobil (XOM), Chevron (CVX) and BP (BP), and all the refiners posted material losses in 2020 due to the pandemic. The minor decrease in revenues and the increase in the distributable cash flow of Holly Energy Partners is certainly outstanding.

Even better, the business outlook of Holly Energy Partners has greatly improved this year. Thanks to the massive vaccination program underway, the pandemic is likely to subside at the second half of this year. The Energy Information Administration [EIA] seems to agree on this view, as it expects the global oil consumption to recover this year, from 92.3 to 97.7 million barrels per day.

Moreover, Holly Energy Partners benefits from an unexpected gift from OPEC and Russia, which have implemented unprecedented production cuts and thus they have provided a strong support to the price of oil. As a result, the price of oil has rallied above its pre-COVID level this year, to a 13-month high. This rally has led many U.S. shale oil producers to return to production mode and hence the U.S. active rig count has increased in 13 of the last 14 weeks. As long as OPEC and Russia continue to support the oil market, the U.S. oil production will continue to recover and thus the U.S. refining margins will improve, assisted also by the improved demand for refined products. The resultant increase in the transported and stored volumes of crude oil and refined products will greatly benefit Holly Energy Partners.

Distribution

Holly Energy Partners raised its distribution for 58 consecutive quarters at a 7% average annual rate until last year. As this period includes the Great Recession and the fierce downturn of the energy sector between mid-2014 and 2016, the exceptional distribution record of Holly Energy Partners is a testament to its robust business model.

Unfortunately, Holly Energy Partners cut its distribution by 48% last year. However, it is important to note that the distribution cut was not obligatory. The MLP could maintain its previous distribution thanks to its reliable cash flows but it chose to slash its dividend in order to preserve cash amid the uncertainty caused by the pandemic. It is remarkable that Holly Energy Partners posted an exceptionally strong distribution coverage ratio of 1.92 in 2020. Such a healthy coverage ratio in the worst year of the energy market in decades is a testament to the safety of the distribution.

Holly Energy Partners also has a healthy balance sheet. Its leverage ratio (net debt to EBITDA) is 4.0 and management recently stated that it will continue to use the excess cash flows to reduce the leverage ratio to 3.0-3.5.

Moreover, despite the distribution cut, the stock is still offering a 7.7% distribution yield.

Data by YCharts

This yield is certainly attractive for income-oriented investors, particularly given the wide margin of safety.

Final thoughts

The breathtaking rally of Holly Energy Partners in recent months has led the distribution yield of the stock to decrease from 11.0% to 7.7%. However, investors should not dismiss the stock for this reason. The stock is still offering an attractive yield, with a wide margin of safety even in the most adverse scenario of a prolonged pandemic. Therefore, income-oriented investors should lock in the 7.7% yield of Holly Energy Partners before it drops further.

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.