Around eighteen months ago I introduced a relatively young master limited partnership (MLP): Shell Midstream Partners (NYSE: SHLX). As its name suggests, Shell Midstream is a dropdown MLP consisting of certain midstream oil & gas assets initially spun out of Royal Dutch Shell. Now, for the conservative income investor assets like oil pipelines and terminals are great in theory. In return for transporting/storing oil, gas and refined products the partnership gets a cut based on the volume being shipped. Think of it as the energy equivalent to operating a toll booth; a great asset to own if you want reliable income.
That is the theory. In practice things are a bit more complex. For instance oil pipelines and terminals don’t just spring out of thin air; this is an incredibly capital intensive industry and that kind of infrastructure costs a lot to build out. Furthermore, the inherent nature of oil & gas production means that crude product pipelines aren’t going to be in demand for ever. Shell Midstream, for example, is heavily exposed to offshore production in the Gulf of Mexico. (Total offshore throughput volume is around 1.9 million barrels per day and accounts for a huge chunk of the partnership’s net income).
On the plus side, a toll booth business model is less susceptible to the kind of volatility that producers or refiners experience as result of commodity price changes. For instance check out the Bengal pipeline system, which Shell Midstream has an interest in via a 50% stake in the Bengal Pipeline Company LLC. Bengal is a refined products pipeline system that connects a handful of refineries in southern Louisiana to various other longer-haul pipelines.
Over the past few years throughput in Bengal has averaged around 500,000 barrels per day. In 2018 Shell Midstream’s cut came to around ¢34 per barrel. In the year before that, revenue per barrel was also ¢34. You can probably guess what it was in 2016. Granted, not all of Shell Midstream’s assets report numbers as tidy as that, though average them out and you find group revenue is quite stable for a commodity company.
A couple of other points put Shell Midstream at the better end of the MLP spectrum. Firstly, it tends not to build the infrastructure itself, rather they are “dropped down” from the parent company (i.e. Royal Dutch Shell). Now of course this doesn’t happen free of charge; the partnership has taken on around $2 billion worth of debt and issued an extra 150 million units since IPO in order to fund these transactions. But getting assets that already exist and collect revenue is less risky than planning and building them from scratch.
Secondly, and as far as MLPs go, Shell Midstream has numerous growth drivers. The most obvious one is the parent company itself which still has numerous assets it can dropdown to the partnership (and more are currently under construction). Indeed as I write Shell Midstream has just acquired interests in two refined products pipelines from Royal Dutch Shell. Production in the regions served by the company’s assets has also been steadily rising. In the Gulf of Mexico for instance overall production is forecast to reach 2.1 million barrels in 2020; up over 50% on 2015 production.
This all feeds through to Shell Midstream’s operational performance. The past twelve months has seen offshore pipeline throughput increase to the aforementioned 1.9 million barrels per day from 1.4 million. And more volume equals more cash. Over the three months ended December 31st, 2017 (i.e. the period in which I penned the first piece) Shell Midstream reported distributable cash flow (DCF) of around $95 million. In the equivalent period last year that figure had jumped to around $150 million. Even after taking into account unit dilution that is an impressive performance. (DCF basically equals EBITDA less interest payments, taxes and maintenance capital expenditures).
As you would probably expect the rapid growth in cash flow has translated into healthy per-unit dividend growth. In its first full calendar year as an independent entity Shell Midstream paid a total distribution of around ¢67 per unit. Last year it paid $1.43 per unit, and it is on course to pay around $1.70 in 2019. Finally, the balance sheet is in decent condition. Total debt net of cash currently stands at around $1.90 billion on the back of $620 million worth of annual EBITDA. With an annual interest bill of around $65 million servicing its debt obligations shouldn’t be an issue.
The bad news is that the units have been a dud for a while now in terms of share price. (As it stands they are trading for around $20.50 apiece on the New York Stock Exchange; around 50% lower than their 2015 highs). The good news is that we are now heading into deep value territory. If Shell Midstream were to freeze its distribution at the current quarterly level of ¢41.50 then we would still be left with a yield north of 8%. (The coverage on that – i.e. the DCF per unit dividend by the unit price – is around 1.2). If we assume growth continues as forecast then we are very quickly hitting the 9%-10% yield mark. For a fairly conservative investment vehicle the prospect of getting your investment paid off within a decade is a good one.