Master Limited Partnership’s have unique characteristics which may determine the future performance of distribution growth and price appreciation. The following is a key list of attributes which should be considered when selecting individual MLP’s for your investment portfolio:
Commodity Exposure: MLP’s can have exposure to one or more commodities, such as Coal, Oil, Natural Gas and Petroleum products, for which the underlying commodity performance can impact the cash flows of the MLP. Identifying the current, and potentially future, commodity exposure is a key selection criteria.
Value Chain: Indicates where the MLP assets operate in the production chain. Upstream assets are related to exploration and production, Midstream assets are involved with transportation between producer and distributors, and Downstream assets are related to end user distribution. Upstream and Downstream assets have higher exposure to commodity price and demand changes. Midstream assets are often contracted fees over a long period of time. MLP’s often do not fit exclusively into one category, but understanding where the majority of the cash flows are generated is another key selection criteria.
Partnership Type: Master Limited Partnerships have two entities, the General Partner, which manages the partnership assets and has voting rights for board membership, and the Limited Partner, which is a passive interest having no operating role in the partnerships assets, but has ownership rights to the distributions. Some General Partners, and all Limited Partnerships, are publicly traded.
Distributable Cash Flow: A company frequently provides non GAAP table which indicates the cash available for distribution. Understanding how cash is generated, and the accounting of non-cash items, is important for assessing the quality of the current cash flows and potential for future distribution growth.
Distribution Growth: The rate at which the quarterly or annual distributions are growing is a key measurement of asset utility and management effectiveness.
Coverage Ratio: A quarterly or annual measure of the amount of cash available from operations, also known as Distributable Cash Flow, divided by the amount of actual cash distribution to all units holders, including limited partners, general partners, and subordinated units. A Coverage ratio equal to 1 indicates that the cash generated (DCF) from the MLP is equal to the distribution for that period. Coverage ratios can be higher and lower than 1 due to the cyclical nature of some cash flows as well as certain non-cash accounting adjustments.
Incentive Distribution Rights (IDR’s): The General Partner can have the right to receive a higher distribution payout if they are able to increase distributions according to a published schedule. Such an agreement is meant to further incent the General Partner to increase distributions to all unit-holders. Understanding whether an MLP has an IDR agreement with their GP is a key selection criteria.
Tax Treatment: MLP’s can be structured for K-1 or 1099 distributions, by way of cash or in-kind (stock) distributions. Understanding the type of distribution in advance of the investment will allow for proper tax and income forecasting.
Subordinated Shares: Units often have secondary rights to distributions according to a published schedule. Such units can impact the potential for overall distribution growth. Knowing whether an MLP has subordinated units, and the number of units, should be part of the MLP selection process.
Historical Spread: The historical and difference between the MLP Distribution yield and the 10 Year Treasury provides information as to how the market may react to a future rate change holding all other factors constant.
1 . High Risk of Distribution Cut
2 . Distribution At Risk
3 . No Risk of Distribution Cut
4 . No Risk of Distribution Cut; Growth at Risk
5 . No Risk of Distribution Cut; Strong Growth