MPLX Cuts Dividend Growth Guidance in Half: What This Means for Long-Term Investors

Source: MPLX

The worst oil crash in half a century has decimated almost all energy stocks, even midstream MLPs, whose toll booth like business models supposedly insulated their cash flow from commodity prices. However, some MLPs, such as MPLX (MPLX 1.25%) have been battered far worse than their peers.

MPLX data by YCharts

Let's look at four factors from MPLX's latest earnings report to see just why Wall Street has punished the fast growing midstream MLP so severely. More importantly, find out if MPLX still represents a remarkable long-term income growth opportunity or is a value trap that should be avoided.

Results themselves were fantastic but...

Source: earnings release

MPLX closed its merger with MarkWest Energy Partners on December 4, 2015 which explains the stupendous growth in its year-over-year results. However, given the greatly increased unit count (due to the amount of equity issued by the MLP to help pay for the acquisition) investors should focus on this latest quarter to get a better sense of MPLX's DCR going forward.

Luckily, at 1.2, the MLP's current payout, remains highly sustainable, despite the 10.9% yield that indicates Wall Street is pricing in a high risk of a payout cut in 2016. But if MPLX's distribution is reasonably safe, then what explains the market's recent routing of the unit price?

...Payout profile weakened by distribution guidance cut
Before the merger with MarkWest MPLX was guiding for long-term distribution growth of approximately 25% per year, inline with its historic payout growth rate. However, management's announcement that it forecast only a 12% to 15% distribution increase in 2016 shocked investors and has resulted in a unit price collapse of as much as 25% since earnings were released on February 3.

Why would management slash payout growth expectations by 50% given how much larger MPLX has grown thanks to this merger and given that its potential growth backlog has now grown to as high as $33 billion?

Source: MPLX investor presentation.

The answer is largely two fold: increased exposure to commodity price based volatility and a much more leveraged balance sheet.

MarkWest isn't fueling the expected short-term boom in DCF
In Q4 MPLX's pre-merger assets generated $243 million in DCF while MarkWest actually resulted in -$16 million in distributable cash flow. This shortfall was due to gas prices being so low that gas producers are rapidly cutting back production, resulting in declining demand and volumes for MarkWest's pipelines and gas processing facilities.

In addition, MPLX is guiding for full year 2016 DCF of between $970 million to $1.1 billion, nearly unchanged from the pre-merger annualized DCF rate $972 million it generated this quarter. This indicates that management believes the MarkWest merger won't be accretive to short-term DCF in 2016.

Still MPLX's 2016 DCF guidance results in an expected DCR of between 1.19 and 1.22, when accounting for 15% and 12% distribution growth, respectively. This indicates that, barring a continued slide in natural gas prices that might cause DCF to fall far short this year, the MLP should be able to sustainably achieve its payout growth target. 

However, the other major reason Wall Street hates MPLX right now is that the MarkWest merger is threatening its ability to grow quickly via dropdowns from its sponsor Marathon Petroleum Corp. (MPC 0.47%).

Lack of access to cheap growth capital could hinder short-term growth
As part of the merger MPLX took on $4.1 billion of MarkWest debt, raising its leverage ratio (debt/EBITDA) from 3.1 to 4.7. Management's goal is to reduce that to 4.0 by year's end which means its ability to finance new drop downs in 2016 through debt is severely limited.In fact, management has no plans to take on any additional debt this year.

With its unit price having collapsed -- thus cutting off its access to cheap equity capital -- MPLX now faces a major short-term problem funding profitable growth. Marathon Petroleum Corp. is planning to drop down its inland marine business to MPLX in the second quarter, which is expected to boost the MLP's annual EBITDA by $120 million or 10.5%.

However, given that Marathon Petroleum will be paid entirely in new MPLX equity, the MLP faces the same risk that the deal might actually decrease DCF/unit and reduce its ability to grow its payout sustainably in the future.

Bottom line
MPLX's merger with MarkWest Energy Partners has left its cash flows more exposed to commodity prices and its balance sheet far more leveraged than before. With its access to growth capital now restricted by the collapse of unit price it's understandable and appropriate that management reduced its forecasted distribution growth rate.

That being said, MPLX's distressed yield is pricing the MLP as if the payout were in danger of being cut, which, given the strong DCR, isn't likely. While MPLX is likely to remain a highly volatile MLP, appropriate only for investors with a high-risk tolerance, I remain confident that at today's undervalued price it is likely to make an excellent long-term dividend investment over the next five to 10 years.