MLPs have been on a tear lately, and one of the hottest of them all has been Phillips 66 Partners (NYSE: PSXP). The partnership is comprised of midstream assets dropped down from its sponsor, the refiner Phillips 66 (NYSE: PSX).

Phillips 66 Partners launched on July 23 as one of the most anticipated IPOs of the year. The IPO was initially pegged at 15 million shares in an indicated range of $19 to $21. But demand proved so strong that the deal was upsized to 16.4 million shares and the price increased to $23 a unit.

Even then, investors who were able to get shares before the start of public trading got what proved to be a sweetheart deal. Shares opened more than 25 percent above the IPO price at just under $29 and closed on the first day of trading at nearly $30. To me this seemed a bit exuberant considering that the IPO prospectus put the minimum yield at $0.85 per unit on an annualized basis. At $30 per unit, that translated into an indicated yield of 2.8 percent.

I expected the price to correct downward if the initial distribution was near the minimum. On Oct. 23, the partnership announced an initial quarterly distribution of $0.1548 per unit, which was based on the $0.85/unit minimum but prorated since the IPO took place during the quarter. Units did decline by about 6 percent over the next month, but have soared since that late November low point.

PSXP made a strong move up in December, before the partnership declared a fourth-quarter distribution of $0.2248 per limited partnership unit. This represented an increase of 5.8 percent over the minimum, and shares rallied further from that point.

On Jan. 22, the day the fourth quarter distribution was declared, units traded at $38. This represented a 31 percent gain in six months for those that bought in at the start of trading following the IPO, and a 65 percent gain for those who managed to get allocated shares at the $23 IPO price. At that point the annualized yield of 2.4 percent was even lower than at the close of first day of trading, and investors could certainly be forgiven for taking profits.

But they would have done so just before units had their biggest rally to date. Between Jan. 22 and April 17, units advanced another 54 percent to close Thursday at $57.66. Investors who got in at the IPO price have now seen a 151 percent gain, while those who bought at the start of the first day of trading and held have gained 94 percent. Not bad at all for a conservative midstream MLP. But the rally has the annualized yield now pushed down to 1.6 percent — its lowest yet.


PSXP performance since IPO

It would be easy to conclude that PSXP is overextended at this point, but one of the major factors behind the rally was the partnership’s first post-IPO acquisition in February. The acquisition included Phillips 66’s Gold Product Pipeline System (the “Gold Line System”) and the Medford Spheres, two newly constructed refinery-grade propylene storage spheres.

According to the PSXP press release announcing the acquisition, the Gold Line System consists of a 681-mile refined products pipeline system that runs from the Phillips 66 operated refinery in Borger, Texas, to Cahokia, Ill., with access to the Phillips 66 refinery in Ponca City, Okla., (where I once worked, incidentally) as well as two parallel 54-mile lateral lines from Paola, Kan., to Kansas City, Kan. The system has a maximum throughput capacity of 132,000 barrels per day and includes terminals in Wichita, Kan., Kansas City, Kan., Jefferson City, Mo. and Cahokia, Ill., with 172,000 barrels per day of aggregate throughput capacity and 4.3 million barrels of storage capacity.

The Medford Spheres are located in Medford, Okla. and have a total working capacity of 70,000 barrels. They were scheduled to commence operation March 1, providing an outlet for delivery of refinery-grade propylene from the Phillips 66 refinery in Ponca City, Okla., through interconnections with third-party pipelines to Mont Belvieu, Texas.

The partnership announced that it will finance the $700 million acquisition with cash on hand of $400 million, the issuance of additional units valued at $140 million, and a 5-year, $160 million note payable to a subsidiary of Phillips 66. (Phillips 66 shares have also rallied by 9 percent since the announcement.) Issuance of the new units results in an approximate 5 percent dilution.

This dropdown took place March 1 and was expected to be immediately accretive to earnings and distributable cash flow (DCF). The partnership expects the new assets to contribute EBITDA of $65 million to $70 million during the first full year of operation — roughly double the annual pre-acquisition EBITDA.

Thus, units have rallied on the expectation of a rough doubling of DCF, and hopes that PSX will drop down additional assets. Investors who are looking for a growth story may find one here, but PSXP’s fortunes are somewhat tied to those of Phillips 66. The refining industry is very cyclical, but Phillips 66 is one of the more diversified and vertically integrated refiners.

In conclusion, I would only suggest this MLP for aggressive investors looking for a growth story. Even then, I think buying at the current price runs a significant risk of being caught in a correction. My recommendation for investors interested in PSXP is to wait for a pullback, while recognizing that if the partnership announces more acquisitions in the near future one may not be forthcoming.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Updates

Warming Up to Kinder Morgan

Kinder Morgan (NYSE: KMI) delivered slightly better than expected operating results last week, alongside new long-term natural gas transport deals bearing out its founder’s bullishness on the business. The share price ticked higher, recovering fully from the recent dip if not yet from the longer-term slump that has now lasted 11 months.

Given the bullish long-term fundamentals, that’s probably long enough. We’re upgrading KMI to a buy below $37. In a year when the partnership family’s growth has been slowed by recent investments and acquisitions, general partner KMI remains on track to lift its dividend 8 percent, while already providing a decent and reliable 5 percent yield. Its exposure to long-term growth in gas transport volumes is unparalleled. Also unparalled is the constancy and scale of insider buying in this corporate flagship.

Despite the recent bounce, KMI remains 18 percent below last May’s record high, and coincidentally at about the same discount to the vesting price of warrants expiring in three years that the company has recently been repurchasing. These repurchases are being carried out by heavily invested management that could pull off a personally lucrative restructuring transaction at any time to take the focus off the rich tribute KMI collects from subsidiary partnerships.

Kinder Morgan Energy Partners (NYSE: KMP) saw its cash earnings in the key gas transportation segment rise 12 percent year-over-year after excluding the boost from last year’s acquisitions. The bitterly cold winter played a part, boosting KMI’s volumes 5 percent year-over-year in the first quarter, and to 33 percent of total US demand in January.

More importantly, KMP and El Paso Pipeline Partners (NYSE: EPB) inked new pacts (averaging 15 years) during the quarter for the transport of natural gas totaling 2.8 billion cubic feet per day, representing more than 10 percent of their combined recent shipment volume.

Deals have been signed with the fast-growing Marcellus and Utica driller Antero Resources (NYSE: AR), which will be shipping to the Gulf Coast, as well as with a liquefied natural gas export venture in the region and with distributors across the Southeast.

Founder Richard Kinder was also extremely upbeat about the prospects of transporting Marcellus gas into New England and Eagle Ford’s into Mexico, which could double its imports of US gas over the next decade.           

Within three years, KMI should also benefit from the launch of LNG exports by a joint venture between El Paso and Shell (NYSE: RDS-A).

Most of the analysts’ questions on last week’s revolved around these positive developments, while the accounting criticisms leveled by Hedgeye research shop last year went unmentioned. At this point, investors troubled by the bookkeeping have had six months to sell.

Some of the recent pressure on the share price has come from short sellers who have dramatically increased short interest since the end of February.With fundamentals improving and the stock apparently on the mend, the bears are paying the yield while playing liar’s poker against Rich Kinder. We’d rather bet on Kinder in this game. Buy KMI below $37.     

Hedgeye Leans on Atlas

The unit price of Atlas Resource Partners (NYSE: ARP) dropped 5 percent Monday after Hedgeye energy analyst Kevin Kaiser tweeted that  two affiliates, Atlas Energy (NYSE: ATLS) and Atlas Pipeline Partners (NYSE: APL) have been added to his Best Ideas list as shorts and, along with ARP, offer “considerable downside.”

Hedgeye will release its report to “institutional” subscribers Thursday, but has apparently revived its standby charge that capital raises are being used to finance distributions. This is not a bit surprising or untoward for a young MLP like Atlas Resources still making heavy investments in future growth.

But MLP investors have learned the hard way to get out of the way of prolonged short attacks such as those still bedeviling Kinder Morgan and Linn Energy (Nasdaq; LINE). For Atlas Resources, this too shall pass, leaving a double-digit yield with significant upside from higher natural gas prices. Buy ARP below $23.

Paddling Upstream

We are less enthused about Mid-Con Energy Partners (Nasdaq: MCEP), because despite a comparable yield it offers much less growth and upside potential than ARP. Like other oil and gas producers among MLPs, MCEP pays a generous distribution, currently yielding 9.2 percent.

But almost none of it is a return from operations. Instead, of the roughly $56 million in cash generated from operations last year, Mid-Con spent $50 million on capital expenditures, including $28 million on purchases of production interests and $22 million on drilling and other development activities. That left some $6 million to be applied toward the $40 million in paid out distributions, the rest made up with borrowed money.

Borrowing to finance growth is not a sin. But the bottom line here is that there are many much more efficient and prolific producers to choose from both inside and outside the MLP space. We prefer ARP and Vanguard Natural Resources (Nasdaq: VNR) among upstream MLPs. Sell MCEP.

— Igor Greenwald