Valero Energy Partners Earnings: Blowout Results Signal Stupendous 2016 Payout Growth

Source: Valero Energy Partners

With few exceptions the worst oil crash in half a decade has taken a toll on almost all energy stocks, even those once thought impervious to commodity prices, such as midstream MLPs. One such exception is Valero Energy Partners (NYSE: VLP) which just announced stupendous Q4 and 2015 earnings results.

Find out just how good they were, but more importantly why dividend lovers can expect continued exceptional distribution growth over the next two years, as well as what risks they need to look out for.

Results don't come much better than this

Source: earnings release, Yahoo Finance

Valero Energy Partners' phenomenal growth was entirely a result of its 2015 drop downs from its sponsor and general partner, Valero Energy Corp. (NYSE: VLO), specifically three distribution terminals.

Further good news came from management's announcement that it had secured an expansion of its revolving credit facility from $300 million to $750 million. This provides the MLP with $656 million in total liquidity with which to continue acquiring Valero Energy Corp's. midstream assets in 2016.  Better yet, thanks to a leverage ratio (Debt/EBITDA) of just 1.1, compared to the industry average of 6.2, Valero Energy Partners should have little trouble accessing additional cheap debt markets.

Payout profile that's the envy of all its peers
One of the most important things dividend investors need to consider when investing in midstream MLPs is the distribution profile, which consists of three things: yield, payout sustainability, and long-term distribution growth potential.

• Yield: 2.9%
• Distribution coverage ratio: 2.06
• Management payout growth guidance: 25% through 2017

While Valero Energy Partners' yield is far the average midstream MLP yield of 7.9%, in all other respects its distribution profile is exceptional, which explains why Wall Street is valuing it at such a premium to its peers.

However, as fellow midstream MLP growth superstar MPLX (NYSE: MPLX) recently showed, when management cut 2016 payout growth guidance in half on February 3 -- very strong payout growth expectations can be a double edged sword if an MLP can't deliver on them.

MPLX Price data by YCharts

Luckily for Valero Energy Partners, MPLX's reasons for slashing its distribution growth projection was due to its recent acquisition of MarkWest Energy Partners, which exposed it to declining gas production volumes in the Marcellus and Utica shale.

Valero Energy Partners' volumes come from Valero Energy Corps.' use of its assets (all of which are under long-term fixed-fee contracts), which means essentially no volume or revenue risk to potentially cause it to miss its payout growth target.

In addition MPLX had to take on $4.1 billion in debt as part of that acquisition, resulting in a 4.7 leverage ratio that management is trying to lower to 4.0 by year's end. This limits the amount that MLP can borrow to fund future growth, a problem not shared by Valero Energy Partners' with its super strong balance sheet.

BUT super growth runway may be a short one
While I'm thoroughly impressed with Valero Energy Partners' growth in 2015, partially fueled by its continuing access to cheap equity capital markets due to its units sporting one of Wall Street's highest midstream MLP valuations. However, there is one major concern I have that investors need to be aware of.

Source: Valero Energy Partners investor presentation.

While Valero Energy Corps.' existing midstream assets may provide the still small Valero Energy Partners' several years of exceptional growth, the shear magnitude of those assets are much smaller than other refiners, such as Phillips 66, Marathon Petroleum, and Royal Dutch Shell, all of which also sponsor fast growing midstream MLPs.

Granted in 2016 Valero Energy Corp. plans to invest $715 million into midstream assets in 2016, and as long as oil remains cheap Valero Energy Corps.' which means its MLP may have three to four years to grow quickly through drop downs from its sponsor.

However, with Valero Energy Partners' projecting just $5 million in organic growth expansion in 2016, investors need to understand that this MLP's hyper-growth is likely to end as soon as its sponsor's drop down pipeline runs dry.

Bottom line
With billions of dollars of additional midstream drop downs coming from Valero Energy Corp, stupendous access to growth capital, and one of the strongest coverage ratio's in the industry, I have little doubt that Valero Energy Partners will hit its 25% payout growth target over the next two years.

However, it's important for investors' to realize that Valero Energy Partners' is current trading at a very high premium, especially relative to its beaten down midstream peers, and once its sponsor's drop down pipeline is dry continued payout growth will likely have to slow substantially. That in turn could result in a valuation contraction past 2017 that might result in Valero Energy Partners underperforming more undervalued midstream MLPs over the next five to ten years.