While we recap distribution growth quarterly (2Q18 recap), two quarters have passed since we last discussed distribution coverage (click here). In today’s post, we show historical quarterly coverage ratios for current constituents of the Alerian MLP Infrastructure Index (AMZI) for 4Q16 and the three most recent quarters. While the data shows improvement for the group, there are some nuances in the changes to coverage ratios for certain constituents, including improvement following distribution cuts or improvement due to the pursuit of equity self-funding. Others have seen coverage ratios decrease as their distributions have increased.
As a reminder, distribution coverage (or coverage ratio) compares distributable cash flow (DCF) generated in a period to total cash distributions paid for that period of performance. A coverage ratio above 1.0x tends to give investors comfort around an MLP’s ability to continue paying or growing its quarterly distribution. On the other hand, a coverage ratio (persistently) below 1.0x can be concerning for investors.
What are the company-level takeaways?
While there has not been much change in the average and median for the group over time, coverage ratio changes for the individual constituents belie the relatively steady average and mean. Some MLPs have provided fairly consistent coverage ratios, while others have seen more notable changes. Unfortunately for investors, improvement in coverage ratios have come at a cost in some cases, with distribution cuts noted for eight names in the table. In other cases, distribution coverage has increased as companies have moved toward self-funding the equity portion of their capital spending. Companies pursuing equity self-funding include Enterprise Product Partners (EPD), MPLX (MPLX), and Magellan Midstream Partners (MMP), which aligns with their comfortable coverage ratios over the time periods shown and an improvement for EPD since it announced its strategy to pursue equity self-funding in October 2017. Double-digit distribution growth has led to moderating coverage ratios for Antero Midstream (AM), Phillips 66 Partners (PSXP), Shell Midstream (SHLX) and EQT Midstream (EQM), but 2Q18 coverage was still 1.2x or greater for these names.
What are the takeaways for the group more broadly?
Comparing 4Q16 to 2Q18, the average for this group has remained steady, while the median has slightly improved. That said, the data below seems more telling of the improvement for the group. In summation, the number of companies with coverage of 1.2x or better has increased from 4Q16, while the number of names with coverage below 1.0x has decreased. For investors, these numbers are both trending in the right direction in terms of providing more comfort around the ability of these MLPs to pay their distributions or increase them. The table above shows the simple average for each quarter, but the weighted average coverage ratio for 2Q18 is also 1.2x based on the index weightings as of the August 10th special rebalancing.
Cautions to keep in mind
As a metric that does not comply with Generally Accepted Accounting Principles (GAAP), MLPs have latitude in how they calculate DCF. Among different MLPs, DCF may not be calculated in the same way, implying that the coverage ratios shown are not all apples to apples. That said, comparing coverage ratios over time for the same company should provide a clear comparison for that individual company. For businesses with seasonality, coverage may fluctuate between quarters making an annual or trailing 12-month coverage ratio more meaningful. As noted in the table, NGL Energy Partners' (NGL) trailing 12-month coverage ratio is 0.9x – much higher than the 0.4x shown for 2Q18. NGL has moved to reduce the seasonality of its business with the sale of its retail propane business, which closed last month.
Rounding coverage to the tenths place also smooths the data. However, we think presenting the data to the hundredth place implies more accuracy for the data broadly than is warranted given the caveats mentioned above, namely that DCF is not a standard measure.
Looking at the current AMZI constituents, distribution coverage has generally improved from 4Q16 to 2Q18, though in some cases that improvement was the result of painful cuts to lower the distribution to a more sustainable level. Each MLP’s coverage trends are somewhat unique, whether coverage was steady, decreased due to distribution growth, or coverage improved because of cuts, a shift to self-funding, or an effort to be more conservative. However, for MLP investors, the improvements discussed or the absolute numbers for 2Q18 hopefully help address concerns about coverage and the ability of MLPs to pay and potentially grow their distributions.