Two master limited partnerships began trading publicly this month following initial public offerings. The crude royalties harvester with a modest yield proved much more popular than the coal miner with a decent one.  

Foresight Energy Partners (NYSE: FELP) is a coal producer operating four underground mining complexes in the Illinois Basin. The partnership was formed in 2006 to develop and operate the Illinois mining assets of the Cline Group, a prominent mine developer. The $350 million IPO represented a 13.5 percent limited partner interest, putting the total market capitalization at $2.6 billion. The partnership has $1.3 billion of debt, giving it an enterprise value (EV) of $3.9 billion. The Cline Group owns 70 percent of the general partner, while private equity group Riverstone owns the other 30 percent.

Foresight Energy Partners is one of the largest owners of coal reserves in the US, and claims to be the lowest cost and highest margin domestic thermal coal producer. At 2014 production levels, the partnership’s more than 3 billion tons of coal reserves are equivalent to 125 years of production. FELP produced 18 million tons of coal in 2013, and expects to produce 24.1 million tons in the 12 months ending June 30, 2015.

FELP’s reserves and mines are located near multiple rail and river transportation access points, and it owns a 25 million ton per year barge loading river terminal on the Ohio River. It also has access to Gulf of Mexico terminal capacity of 12 million tons per year via contracts.

The IPO filings projected $412.9 million in EBITDA over next 12 months, giving the partnership an EV/EBITDA multiple of 8.5x. The partnership projects a minimum quarterly distribution of $0.3375, putting the annual yield at 6.75 percent based on the $20 targeted IPO price.

Foresight Energy Partners debuted on the New York Stock Exchange on June 18, and units traded down 4 percent following the IPO. While some may question the wisdom of a new coal MLP given the general outlook for coal in the US, the coverage ratio is projected to be a conservative 1.3x for the next 12 months. The projected yield has risen to 6.9 percent based on Friday’s close of $19.57.

Viper Energy Partners (NASDAQ: VNOM) also debuted on June 18, but saw much stronger demand. VNOM is a spinoff from one of the hottest independent oil and gas producers in the Permian Basin, Diamondback Energy (NASDAQ: FANG). Since its own IPO in October 2012, Diamondback Energy has rallied more than 400 percent, and its market capitalization has grown to $4.6 billion.

Viper Energy Partners owns mineral rights on 14,804 acres in the Permian Basin in West Texas, with an average 21 percent royalty interest on the oil and gas production. These mineral rights are leased to working interest owners who bear the costs of operation and development. Viper Energy Partners becomes the first US-listed partnership to rely on royalty payments, and it plans to grow distributions by acquiring additional mineral rights in the future.

Viper Energy Partners had scheduled the $100 million IPO at a price range midpoint of $20. The IPO represented 7 percent of the limited partner interest, with Diamondback Energy owning the other 93 percent, and the $20 share price would have valued the entire partnership at $1.5 billion. But demand proved extremely strong, and units priced at $26, then jumped to $34 during the first morning of trading.

The IPO filings projected $83.8 million in EBITDA over next 12 months, giving the partnership an EV/EBITDA multiple of 18.2x. The partnership expects to distribute $1.0994/unit over the next 12 months, putting the coverage ratio at 1.0x with an annual yield at 5.50 percent based on the $20 target price. However, with the unit price closing Friday at $33.99, the projected yield has dropped to 3.2 percent.

Given the commodity risk associated with Viper Energy Partners’ business model and the now paltry 3.2 percent yield, this security could prove quite poisonous should commodity prices fall or interest rates rise.

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

Portfolio Updates

Targa a Moving Target   

When we added Targa Resources (NYSE: TRGP) to the Growth Portfolio on Nov. 15, 80 percentage points of total return ago, it was with the idea that the company could “fetch a fat premium” in a buyout. Targa’s Gulf Coast fractionation facilities and liquefied petroleum gas export terminal, along with the long-term gathering contracts in some of the fastest growing domestic shale plays, would be difficult to replicate at any price in a reasonable time frame.

That sense, and Targa’s continuing rapid growth, drove the handsome gains in the stock even before last week’s big news of merger talks with Energy Transfer Equity (NYSE: ETE) shifted the rally into overdrive.

The Bloomberg story on the afternoon of June 19 valuing Energy Transfer’s bid at more than $15 billion sent shares zooming 19 percent higher in the last minute before the market close. Later that evening, Targa issued a statement reporting that “high-level preliminary discussions” with Energy Transfer about a merger “have been terminated,” but left the door open to the possibility that they “could resume.”

A Bloomberg update out late Monday blamed the leak for scuttling the talks, reportedly by making Targa’s board worry the offered price wasn’t high enough. But it seems at least as likely that the parties reached an impasse over the buyout price before, hence the leak turning Targa into a very public quarry.

Both sides now have considerable risk if they don’t strike a deal. Targa risks seeing its speculation-aided share price deflate significantly, should ETE definitively back out. In turn, Energy Transfer chief Kelcy Warren has his reputation as a master dealmaker on the line, along with the possibility that Targa might eventually merge with a rival giant.

Targa shareholders, along with unitholders of its subsidiary MLP, Targa Resource Partners (NYSE: NGLS) face downside risks as well should a deal fail to be consummated, yet could miss out on more upside if the merger comes to pass. One way to hedge against either possibility would be to sell some of your holdings. We’re changing our recommendations on TRGP and NGLS to Sell Half for those who can do so without adverse tax consequences. And, tax considerations aside, consider lightening up on NGLS first. As the general partner controlling assets of the MLP, TRGP is likely to command the lion’s share of a premium in any merger. 

EQT Midstream Another Sell-High Candidate      

There should be fewer tax disincentives involved in lightening up on EQT Midstream (NYSE: EQM), like Targa a recent Best Buy, and one that has returned 116 percent for subscribers who followed our Aug. 12 buy recommendation.

EQT Midstream is still growing fast thanks to strong demand for gas transmission and midstream gathering services in the Marcellus shale, where sponsor EQT (NYSE: EQT) remains one of the most prolific drillers. EQM’s distributions per unit are forecast to increase 29 percent this year and 22 percent in 2015 following additional asset dropdowns by EQT.

But those dropdowns will require heavy additional unit issuance, capping a yield that, at 2 percent, already looks unjustifiably low, notwithstanding the current MLP investor preference for growth. If EQM grows its distributions as fast as it hopes and the unit price does not budge from current levels, in 18 months EQM would yield 2.8 percent. Could it double from current levels to yield 1.4 percent by then, as Phillips 66 Partners (NYSE: PSXP) does already? That seems unlikely. More probably, higher interest rates and frustration with slowing capital gains are likely to diminish the attractions of a yield below 3 percent by the end of next year.

EQM has also benefited of late from its inclusion as of Friday in the Alerian MLP Infrastructure Index, and consequently in the ALPS Alerian MLP ETF (NYSE: AMLP), the largest MLP-focused exchange-traded fund with more than $9 billion in assets.

Opportunities to sell high are seldom this obvious. Sell half of your EQM position.

— Igor Greenwald