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Two Top Refining Logistics MLPs

05/16/2016 9:25 am EST


Michael Berger

President & Founder,

Although Michael Berger, Associate Editor of, continues to expect commodity price volatility to act as a headwind for master limited partnerships, he believes the refining logistics space offers investors investments that possess lower commodity risk.

Oil has been volatile with prices trading near its 2016 high and almost 70% above its yearly low.

Nevertheless, many analysts remain bearish and expect oil prices to be affected by a strengthening dollar, weak Chinese data, or an incorrect forecast from the International Energy Agency.

Although we expect oil prices to come down in the next month, we are certainly of the view that oil prices will surge, in the second half of the year.

Lower Commodity Risk in the Refining Logistics Space

If you prefer lower commodity risk while still being exposed to broader energy markets, the refining logistics space is a great place to look.

We believe the refining logistics space provides an attractive total return (dividend yield combined with share price appreciation) as well as exposure to anticipated domestic growth trends while being less exposed to commodity price volatility.

We think the refining logistics sub-sector offers strong visibility into long-term cash flow and income growth with relative insulation from commodity prices and capital markets weakness through the support it receives from its general partner.

Why Invest in the Partnership, Not the Sponsor?

The main reason why we prefer to invest in Master Limited Partnerships (MLPs) is due to the valuation gap between C-corp. refiners and MLPs.

While C-corp. refiners typically trade at a 4-6x EBITDA multiple, refining logistics MLPs trade as high as 20x EBITDA (group average is around 11x).

We believe that this valuation spread ultimately provides refiners the opportunity to maximize the value of their midstream holdings, while continuing to maintain control of the assets.

Why do MLPs trade at a premium valuation?

MLPs are tax-advantaged structures that pay no corporate income taxes. This provides partnerships with a competitive tax advantage, and with that a premium valuation.

A refining logistics MLP typically has a clear growth profile backed by visible dropdowns from its sponsor. They provide their sponsor with a much lower cost of equity capital, which gives the sponsor the ability to pursue growth opportunities that will eventually be dropped down to the MLP.

In the end, refining logistics MLPs are typically able to pay more for an acquisition or fund a project without negatively affecting earnings. This allows both parties to potentially achieve meaningful accretion from dropdown transactions.

Dropdowns Promote Growth for the Sponsor and the Partner

Another benefit of this relationship stems from the sponsor refiner’s general partner interest in the underlying partnership.
The structure allows the sponsor to sell assets to their respective MLP through dropdowns. The sponsor receives proceeds (typically all cash) without losing control of the assets.
Dropdowns take the growth risk away from the MLP. Projects start at the sponsor-level and are then sold to the MLP once the asset being dropped down is generating cash flow. The market typically expects a clear and consistent process for dropdowns (1 or 2 per year). MLPs with this visible growth profile tend to trade at a higher premium relative to other partnerships.

How to Separate Leaders from Laggards 

One of the most commonly asked questions we receive from investors relates to how we evaluate the strength of refining logistics MLPs.

We take a look at a number of metrics when trying to determine if a partnership represents an attractive investment. Beyond the obvious distribution yield and growth, we look at the following factors: 1) the parent’s dropdown backlog, 2) the ability to grow the dropdown backlog, 3) financial flexibility, and 4) the potential for organic growth at the partnership.

Two Leading Refining Logistics MLPs

Western Refining Logistics L.P. (WNRL) offers investors a 6.7% dividend yield.  The partnership formed in 2013 by Western Refining Inc. (WNR) in 2013 owns, operates, develops, and acquires midstream-oriented crude oil, refined product, and related assets, primarily supporting the parent's refining operations.

Although WNRL has fallen 3.4% this year, its shares are up more than 36% during the last three months. We view the partnership as one of the top refining logistics MLPs due to its attractive growth profile, both through organic investment and dropdowns.

While low commodity prices have weighed on sentiment and fundamentals for midstream partnerships, WNRL’s attractive downstream-centric exposure and logistics focus in the Permian Basin provides insulation from a downturn in oil prices.

Western Refining Logistics has a very attractive long-term cash flow and distribution growth outlook. WNRL has fallen more than 10% from its high on May 2 and we would be buyers on further weakness.

Tesoro Logistics LP (TLLP) is a partnership we have highlighted a number of times this year. On February 29, we highlighted TLLP as an attractive investment opportunity and since then its shares are up more than 23%.

Even with this rally, we continue to see upside to current levels as the current risk/reward profile remains favorable. Its supportive parent company, Tesoro Corporation (TSO), provides excellent financial support and has visible growth due to recent accretive acquisitions and dropdowns from its parent.

TLLP offers investors a 7.1% dividend and we view the partnership as one of the highest-quality growth stories in the MLP industry. We expect to see the company’s cash distribution grow by at least 15% every year for the next three years.

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