Phillips 66 Catches MLP Fever & You Should Too

by Aaron Levitt | July 18, 2013 10:58 am

It seems more and more energy companies are finally taking advantage of the master limited partnership[1] tax structure.

By placing pipeline, storage and terminal assets into an MLP, the sponsoring firms are able to avoid taxes and receive generous distribution payments. The latest company to take the calculated plunge? Refining superstar Phillips 66 (PSX[2]).

The ConocoPhillips (COP[3]) spinoff recently filed paper work for an IPO of its interest in Phillips 66 Partners and to raise funds for more pipeline acquisitions. That IPO could be the biggest MLP of the year and might lead to some pretty big gains for portfolios — not to mention hefty distributions as well.

For investors, the pending partnership is a buy.

$315 Million

Following the examples of Marathon Petroleum (MPC[4]) with MPLX LP (MPLX[5]) and Tesoro (TSO[6]) with Tesoro Logistics LP (TLLP[7]), Phillips 66 is the latest refiner to offer an MLP to the public.

The downstream players have been making some serious coin by spinning off various assets into MLPs. With refining assets and chemical plants, as well as pipelines that feed these facilities, the appeal of the using the MLP tax structure is simple. Many of these assets will earn a higher multiple as part of an MLP than within a traditional corporate structure. At the same time, MLPs help avoid taxation issues and provide their general partners — the sponsoring refining firms — generous distribution payouts.

So it’s easy to see why a firm would want to have a MLP subsidiary if it could.

Phillips 66 formed Phillips 66 Partners — with the potential ticker PSXP[8] — back in February to operate pipelines, terminals and storage systems near its refining infrastructure and is now looking to raise some money for new acquisitions for the MLP. To that end, the refiner plans to sell 15 million shares of the unit for $19 to $21 for total proceeds of about $315 million.

That will represent a 20.9% limited partner interest in PSXP, while Phillips 66 will own the remaining limited partner interest as well as its 2% general partner interest.

The company will initially include certain pipeline, terminal and storage systems — used for crude oil and refined petroleum product transport — in the Central and Gulf Coast regions[9]. These include PSX’s Clifton Ridge crude oil pipeline system in Louisiana, the Sweeny to Pasadena refined petroleum product pipeline and the Hartford Connector refined petroleum system in Illinois. These three pipeline system’s revenue will come strictly from commercial agreements with its refiner parent as they either feed or move product away from its facilities.

Why the IPO Is a Strong Buy

While the first trading date for PSXP shares hasn’t been set yet, investors might want to consider buying shares when they finally do hit the tape. Overall, Phillips 66 Partners could be one of the biggest MLP launches of the year.

Like several of the other recent MLP IPOs, PSX/PSXP will benefit from the beautiful “drop down”[10] relationship.

After acquiring new pipelines or gathering facilities, general partners often will pass along some of the prime assets into their MLPs. These asset sales are priced at a level that guarantees cash flow accretion for the MLPs and enables the MLPs to raise distributions at a faster.

Phillips 66 has some pretty significant midstream business — outside of what it will initial include in PSXP — and management is already looking for growth opportunities, especially in exports. According to the official Securities and Exchange Commission filing[11], the partnership expects that its parent “will offer us opportunities to purchase additional transportation and midstream assets that it may acquire or develop in the future or that it currently owns.” That includes a right of first offer on its one-third equity interest in the new Sand Hills pipeline located in the Eagle Ford shale as well as its one-third equity interest in the Southern Hills gathering system.

Those additional pipeline systems — along with PSX’s three natural gas liquids fractionators — will do wonders for PSXP’s distributable cash flows. Already, management at the new MLP has agreed to pay 21.25 cents per quarter — which works out to be a 4.25% yield at the midpoint IPO price. That’s a pretty strong starting yield. At the same time, the units of PSXP that the refiner parent owns, along with the incentive distribution rights on its GP assets, should help boost PSX’s 2.1% yield.

Add in share price appreciation — which looks like it will be huge — and it’s a win-win for shareholders. Investors went crazy for Marathon’s MPLX spin-off; PSXP will be better given its NGL and chemical exposure.

Buying IPOs on their first day of trading can be a hit-or-miss proposition. However, this spinoff is definitely one you want to get your hands on.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Endnotes:
  1. master limited partnership: http://investorplace.com/2013/06/devons-mlp-plans-fall-on-deaf-ears/
  2. PSX: http://studio-5.financialcontent.com/investplace/quote?Symbol=PSX
  3. COP: http://studio-5.financialcontent.com/investplace/quote?Symbol=COP
  4. MPC: http://studio-5.financialcontent.com/investplace/quote?Symbol=MPC
  5. MPLX: http://studio-5.financialcontent.com/investplace/quote?Symbol=MPLX
  6. TSO: http://studio-5.financialcontent.com/investplace/quote?Symbol=TSO
  7. TLLP: http://studio-5.financialcontent.com/investplace/quote?Symbol=TLLP
  8. with the potential ticker PSXP: http://finance.yahoo.com/news/phillips-66-partners-launches-initial-120000321.html
  9. Gulf Coast regions: http://investorplace.com/2013/07/get-ready-for-the-next-texas-oil-rush/
  10. “drop down”: http://investorplace.com/2013/06/do-the-drop-down-dance-with-spectra-energy/
  11. official Securities and Exchange Commission filing: http://www.sec.gov/Archives/edgar/data/1572910/000119312513289916/d485877ds1a.htm

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