Phillips 66 Partners Earnings: Blowout Results But Challenges May Lie Ahead in 2016

Source: Phillips 66 Partners

Certain energy dividend growth stocks seem blessed with the ability to grow like weeds despite the worst oil crash in 50 years, such as Phillips 66 Partners (PSXP). In fact the midstream MLP just announced record smashing results that gave investors a lot to cheer about. Learn just how great they were, but more importantly, the biggest growth risk facing Phillips 66 Partners in 2016.

Growth engine firing on all cylinders

Sources: Yahoo Finance, earnings release presentation, 10-Qs

Any way you cut it Phillips 66 Partners had a fantastic fourth quarter and 2015. This was mainly due to last year's $1.1 in organic growth projects and drop downs from its sponsor, manager, and general partner Phillips 66 (PSX 0.92%).

For example, in the fourth quarter the MLP completed its acquisition of Phillips 66's 40% interest in the Bayou Bridge pipeline and Palermo rail terminal.

For 2016 many of last year's acquisitions provide ongoing organic growth opportunities, with Sacagawea pipeline and the first stage of the Bayou Bridge pipeline scheduled to come online in the Q3 and Q1 respectively.

What matters most to income investors
Let's face it the entire purpose of owning a midstream MLP is for the income and when it comes to two aspects of the payout profile -- sustainability and growth -- Phillips 66 Partners hit it out of the park.

Not only did the MLP achieve an impressive 1.44 distribution coverage ratio but it managed to do this while growing its payout 35%. That's even better than management's already spectacular goal of 30% distribution growth through 2018.

In addition Phillips 66 Partners was able to generate $90.4 million in annualized excess DCF. That's cash that will not only help secure the payout in 2016 but also help the MLP achieve strong growth in the years ahead.

High debt: biggest risk to 2016 growth prospects
Few midstream MLPs have better growth prospects than Phillips 66 Partners thanks to the massive drop down pipeline provided by Phillips 66.

Source: Phillips 66 Partners investor presentation.

Not only has Phillips 66 already ear marked billion in future drop down candidates for its MLP to acquire over the next three years, but Phillips 66 is also in the middle of a gigantic effort to diversify into midstream assets.

In fact, over the next three or four years the company expects to construct $8 billion to $9 billion in additional midstream assets, all of which are likely to eventually wind up owned by Phillips 66 Partners.

However, despite a very long potential growth runway Phillips 66 faces two major risk factors in 2016 and both have to do with its growth funding.

First, the MLP has $1.1 billion in debt, which gives it a Debt/EBITDA or leverage ratio of 3.8.Liquidity for future growth consists of $48 million in cash on its balance sheet and an untapped $500 million revolving credit facility that can be expanded to $750 million.

While that may seem like a lot of growth capital keep in mind that that credit facility includes a debt covenant that requires the MLP to maintain a leverage ratio of 5 or less unless it just made a big purchase in which case the limit is 5.5.

That means that Phillips 66 Partners can only borrow $280 million of its credit facility in order to fund an acquisition.

That doesn't mean Phillips 66 Partners can't grow in 2016, however it does mean that the MLP is likely to have to rely heavily upon equity markets to fund ongoing acquisitions. This will dilute existing investors and likely bring down the DCR, especially if management holds to its planned 30% payout growth rate.

Which brings me to the second potential growth risk of 2016. Should oil prices keep falling or stay extremely low Phillips 66 Partners' unit price could take a beating resulting in higher capital costs and less profitable deals.

Bottom line:
Despite the potential for debt and equity markets to potentially muzzle its growth in 2016, I continue to be bullish on this fast growing midstream MLP due to its vast drop down pipeline which could fuel strong growth over the next decade or more.