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My Response To The Recent Article On HEP

|Includes: Holly Energy Partners, L.P. (HEP)

Over the week-end, Dividend Sensei wrote an article on HEP. My comment placed at the end of that article:

I have one major nit-pick - you have omitted the subtraction to HEP's DCF of the portion that goes to the general partner. This results in your DCF/unit number being too high - and significantly distorts (or over estimates) the coverage ratio. That statement is presuming that you are making the same kind of adjustments to DCF as that done by the major brokerages. I believe such an adjustment needs to be done so that one has apples to apples comparison between the MLPs both with and without IDRs (Incentive Distribution Rights) obligations.
After such an adjustment - I believe you will find your statement "the distribution coverage ratio (for HEP) remains among the best in the industry" no longer fits.
Even without that (IMHO) needed correction, I believe this article provides a good service to this audience by shining a light on a MLP that is often 'off the radar' of many investors.

The author's (I will use "DS" going forward) reply: No, the DCF/unit calculations I include are correct. They incorporate the IDRs that the MLP pays.

One of us is wrong. I initiated to correct the author via email - or whatever one should call the messages sent from one person privately to another here at Seeking Alpha:

I probably have an advantage over you - (1) I have access to MLP reports from multiple brokerages. (2) I have been producing data on MLPs since 2005. (3) I know to EXPECT phony numbers from the MLPs.

Take another look at both the net income and the DCF numbers. The earnings release shows both a pre-GP's take income and a post GPs take net income.
Note which 'income' number is used in another earnings release spreadsheet where the DCF calculation is shown. The DCF number you are using comes from a DCF calculation using the pre-GP take net income!
2016 DCF was just short of $2.70. And that $2.70 number matches with the DCF numbers done by Wells Fargo, Barclays and Goldman Sachs.

This may not be the proof you need to change your mind. Such proof probably does not exist. But . . . . it is a decent amount of evidence that I am right.

One more note - to get a good per unit or per share number for the year . . . it is generally accepted practice to use the weighted average unit or share count for the year and NOT the ending unit count.

DCF math is tricky math because one needs to hunt down the needed adjustment numbers. Most investors do not even attempt it. The few who do probably get it wrong.

The DS response - Thanks for the info. I used the Weighted Unit count because that's the average number for the year, and that's the metric I'm trying to report.

My response - The earnings release on 2-21-17 at the HEP web site showed the weighted average unit count as 59,872. You used 62.8 million in the article.

The DS response - Holy crap you're right! Thanks for the catch. I'll re-run the numbers and update them with the corrections.

DS changed - or correctly decreased the unit count in his DCF calculation - but did not correct the DCF numbers - resulting in a larger error in the published calculation.

My response - I am more or less privately showing you the data here in this little read blog.

This is the link to where one can find the information below. The important numbers are well hidden - but I have placed them in bond and italics. Note which 'income' number is used in another earnings release spreadsheet where the DCF calculation is shown. Clue - it is the pre-IDR or General Partners subtraction of income.

         
     

Years Ended
December 31,

      Change from
      2016    

2015 (5)

      2015
      (In thousands, except per unit data)
Revenues                    
Pipelines:                    
Affiliates - refined product pipelines     $ 83,102       $ 81,294         $ 1,808  
Affiliates - intermediate pipelines       26,996         28,943           (1,947 )
Affiliates - crude pipelines       70,341         67,088           3,253  
        180,439         177,325           3,114  
Third parties - refined product pipelines       52,195         51,022           1,173  
        232,634         228,347           4,287  
Terminals, tanks and loading racks:                    
Affiliates       119,633         111,933           7,700  
Third parties       16,732         15,632           1,100  
        136,365         127,565           8,800  
Affiliates - refinery processing units       33,044         2,963           30,081  
Total revenues       402,043         358,875           43,168  
                     
Operating costs and expenses:                    
Operations (exclusive of depreciation and amortization)       123,986         105,556           18,430  
Depreciation and amortization       70,428         63,306           7,122  
General and administrative       12,532         12,556           (24 )
        206,946         181,418           25,528  
Operating income       195,097         177,457           17,640  
                     
Equity in earnings of equity method investments       14,213         4,803           9,410  
Interest expense, including amortization       (52,552 )       (37,418 )         (15,134 )
Interest income       440         526           (86 )
Gain on sale of assets and other income       677         486           191  
        (37,222 )       (31,603 )         (5,619 )
Income before income taxes       157,875         145,854           12,021  
State income tax expense       (285 )       (228 )         (57 )
Net income       157,590         145,626           11,964  
Add net loss applicable to predecessor       10,657         2,702           7,955  
Allocation of net income attributable to noncontrolling interests       (10,006 )       (11,120 )         1,114  
Net income attributable to Holly Energy Partners       158,241         137,208           21,033  
General partner interest in net income, including incentive distributions(1)       (57,173 )       (42,337 )         (14,836 )
Limited partners' interest in net income     $ 101,068       $ 94,871         $ 6,197  
Limited partners' earnings per unit - basic and diluted:(1)     $ 1.69       $ 1.60         $ 0.09  
Weighted average limited partners' units outstanding       59,872         58,657           1,215  
EBITDA(2)     $ 277,545       $ 237,180         $ 40,365  
Distributable cash flow(3)     $ 218,810       $ 197,046         $ 21,764  

The DCF calculation from the earnings release:

Set forth below is our calculation of distributable cash flow.

     

Three Months Ended
December 31,

     

Years Ended
December 31,

      2016    

2015 (5)

      2016    

2015 (5)

      (In thousands)
Net income attributable to Holly Energy Partners     $ 41,361       $ 40,520         $ 158,241       $ 137,208  
Add (subtract):                          
Depreciation and amortization       19,245         16,886           70,428         63,306  
Amortization of discount and deferred debt charges       895         503           3,246         1,928  
Loss on early extinguishment of debt       -         -           -         -  
Increase (decrease) in deferred revenue attributable to shortfall billings       (1,113 )       (190 )         (1,292 )       (1,233 )
Maintenance capital expenditures*       (1,861 )       (3,286 )         (9,658 )       (8,926 )
Increase (decrease) in environmental liability       135         (1,837 )         (584 )       1,107  
Increase (decrease) in reimbursable deferred revenue       (827 )       (495 )         (2,733 )       176  
Other non-cash adjustments       644         1,568           4,683         3,934  
Predecessor depreciation and amortization     $ -       $ (118 )       $ (3,521 )     $ (454 )
Distributable cash flow     $ 58,479       $ 53,551         $ 218,810       $ 197,046  

I know it is not clear as the nose on your face that the $281.810 DCF number is not the calculation for DCF available to the limited partners. One would have had to do the math before.

I have attempted to do a collective effort at DCF/unit calculations on the Investor Village message board. What I learned from a multi-quarter attempt at that effort. (1) 95% or more of retail investors can not do the calculation. (2) The 5% who could learned the process from me. (3) The process I learned still has faults - because I can not match the brokerage produced numbers all the time. (4) I could not have learned what I have learned if I did not have exposure to brokerage reports from multiple brokerages. That exposure is due to the collective efforts of other retail investors. That source is not open to the public.

The HEP spreadsheet I shared with you earlier this quarter:

Holly Energy Partners metrics

From Q4-16 CC: HEP has over 90% of their revenues tied to long term, fee based contracts with minimum volume commitments
  Q4-2016 Q3-2016 Q2-2016 Q1-2016 Q4-2015 Q3-2015 Q2-2015 Q1-2015 Q4-2014 Q3-2014 Q2-2014 Q1-2014 Q4-2013 Q3-2013 Q2-2013 Q1-2013
Revenues 112.526 92.610 94.897 102.010 97.251 88.389 83.479 89.756 88.413 82.130 74.998 87.004 77.876 77.723 75.285 74.298
Costs 57.977 46.138 45.827 46.564 45.623 44.295 43.431 45.950 50.070 43.205 32.033 41.551 47.051 34.173 42.765 43.251
EBITDA 76.868 64.705 66.047 59.827 67,376 59.985 54.453 55.366 52.703 53.790 47.273 57.657 46.613 53.187 47.263 44.990
Total DCF dollars 58.479 49.257 55.709 55.365 53.551 50.306 47.299 45.890 41.835 45.581 43.495 41.808 34.263 43.865 36.065 32.385
GP's DCF dollars 17.172 15.222 12.667 11.886 11.502 10.830 10.196 9.810 9.333 8.940 8.393 8.001 7.485 7.128 6.680 6.231
Gain on sale of assets .574 .112 -.005 0 0 0 .050 .159 0 0 0 0 -53 0 0 0
Net DCF dollars 40.733 33.923 43.042 43.479 42.049 39.476 37.103 35.921 32.502 36.641 35.102 33.807 26.725 36.737 29.385 26.154
Units 62.761 59.223 58.761 58.657 58.657 58.657 58.657 58.657 58.657 58.657 58.657 58.657 58.657 58.657 58.657 56.990
DCF/unit $0.6490 $0.5728 $0.7325 $0.7424 $0.7169 $0.6730 $0.6124 $0.6151 $0.5541 $0.6247 $0.5984 $0.5764 $0.4556 $0.6263 $0.5010 $0.4589
Upcoming Distrib. $0.6075 $0.5950 $0.5850 $0.5750 $0.5650 $0.5550 $0.5450 $0.5375 $0.5300 $0.5150 $0.5070 $0.5000 $0.492 $0.485 $0.477 $0.4700
Calculated Coverage 1.07x 0.96x 1.25x 1.29x 1.27x 1.45x 1.16x 1.14x 1.04x 1.21x 1.18x 1.15x 0.93x 1.29x 1.05x 0.98x
WF DCF/unit $0.67 $0.56 $0.70 $0.71 $0.69 $0.64 $0.62 $0.61 $0.55 $0.62 $0.59 $0.57        
Piper DCF/unit       $0.94 $0.91 $0.86 $0.81 $0.59 $0.78              
UBS DCF/unit   $0.58 $0.67 $0.62   $0.62 $0.60 $0.59                
The DCF/unit numbers from the brokerages fail to agree. My current formula gets me close.
LTM EBITDA 277,545 257,955 253,235 241,641 237,180 222,507 216,312 209,132 211,423 205,333 204,730 204,720 192,053      
Long term debt 1,243,912 1,070,615 1,083,136 1,061,944 1,008,752 951,067 900,905 890,742 867.579 851,416 839,253 833,790 807,630 809,391 799,152 811,913
Debt/EBITDA 4.48x 4.15x 4.28x 4.39x 4.25x 4.27x 4.16x 4.26x 4.10x 4.15x 4.10x 4.07x 4.21x      
Interest Expense 16,294 14,447 10,493 10,535 10,107 9,486 9,056 8,768 8,733 8,585 8,329          
Interest Coverage 4.72x 4.48x 6.29x 5.68x 6.67x 6.32x 6.01x 6.31x 6.03x 6.26x 5.68x          

Note: My 2016 GP's take (17.172 + 15.222 + 12.667 + 11.886) sums to 56.947 million compared to the 57.173 in the earnings release. It is not a match - but it is within 0.4%. Those things happen. There tends to be after the earnings release adjustments to the quarterly numbers.

Note 2: I normally redact the brokerage names. In this case, I believed this message could use the potential confirmation from the audience that the brokerage numbers I provide are accurately duplicating their numbers.

HEP closed today at the price of $34.03. The $0.6075 quarterly dividend comes to $2.43 . . . and thus a (243/3403) 7.14% yield. The Yield plus My CAGR projection of 7.00 comes to 14.14% -- which going by sector average for small caps (BWP, CPPL, DM, GEL, HEP, MMLP, NS, TCP, TEP and TLP), their average Yield + CAGR was 12.33%. Their average yield was 6.56% - with that average being skewed by ultra low payout BWP and ultra high growth DM. A 7% yield looks to fit in with other small cap components. CPPL, DM and TEP have higher "yield + CAGR" numbers - and the same three have higher LTM distribution growth.

If HEP was 40% under valued (which was the assessment of DS), then the resulting yield would need to be (243/ 1.4 times 3403) 5.10%. That would produce a yield + CAGR of 12.10 . . . and that is in line with the current sub-sector average. Thus . . . I do not have a problem with the DS valuation assessment. At the same time, inertia keeps high valued stocks highly valued and lower valued stocks lower valued. I would not make the assessment that HEP is headed to the required (1.4 times 34.03) $47.64 during 2017. It merits being headed towards that valuation without an expectation of reaching that valuation.

This was added to answer darnoc's question -- the data from my CAGR setting spreadsheet:

Co.

    06 07 08 09 10 11 12 13 14 15 16 17 average average CAGRs PI-CAGRs

HEP DCF 1.35 1.54 1.65 1.73 1.75 1.83 2.10 2.08 2.35 2.51 2.67 2.87     My 7.00% RRR-yield 4.74%
  growth   14.1% 7.1% 4.8% 1.2% 4.6% 14.8% -1.0% 13.0% 6.8% 6.4% 7.5% 7.92% 9.78% Last5 6.54% P/DCF Ratio 2.30%
  Dist. 1.25 1.35 1.45 1.53 1.61 1.69 1.77 1.88 2.00 2.12 2.26       Broker1 4.30% Broker2 0.00%
  growth   8.0% 7.4% 5.5% 5.2% 5.0% 4.7% 6.2% 6.4% 6.0% 6.6%   6.11% 8.08% Broker3 0.00% Broker4 0.00%
  Dist/DCF 93% 88% 88% 88% 92% 92% 84% 90% 85% 84% 85%   87.72%
 

When I average the DCF growth numbers from the 5 years of DCF volatility between 2010 and 2014 (1.2 + 4.6 + 14.8 - 1.0 + 13.0) - I get 6.52%.
2015 growth was 6.8%; 2016 growth was 6.4%; 2017 is projected at 7.5%; 2018 growth at 2.71% and 2019 growth at 0.7%.
There is little growth projected in 2018 and 2019 . . . but that could be due to lack of company guidance for those years.
It may also be the case that DCF growth primarily originates (deep thought warning) from drop down acquisitions at attractive Price/EBITDA numbers . . . and there is no acquisition guidance for 2018 and 2019.
I have provided the 2018 and 2019 numbers -- but ignore them.
I see a DCF growth trend in the mid 6s . . and distribution coverage improving . . which implies slightly better distribution growth in the short term. HEP has a goal of 8% distribution growth.
Some companies produce goals that they will - on auto-pilot - meet or exceed. The 8% goal does not look like one of those. I have the perception that the 8% goal requires some good fortune.

Disclosure: I am/we are long GEL.