This MLP Could Offer Retirees Sustainable Income

By Matthew DiLallo Markets Fool.com

Master limited partnerships (MLPs) have long been go-to income sources for retired investors because these entities have to distribute the bulk of their earnings back to unitholders for tax purposes. That said, not all MLPs have been able to maintain the steadily growing payout they promised investors due to the impact of the oil market downturn on their finances. However, one company that bucked this trend and has consistently grown its distribution throughout the downturn is Phillips 66 Partners (NYSE: PSXP). Because of that strength amid the storm, as well as what's clearly ahead, this MLP looks like a great option for retirees seeking steady income.

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A solid foundation

Refining giant Phillips 66 (NYSE: PSX) formed Phillips 66 Partners in 2013 to help drive its midstream growth strategy. However, despite the focus on growth, Phillips 66 has maintained a high level of financial discipline with its MLP to ensure it can deliver as promised. The foundation of that discipline is a focus on building and buying primarily fee-based assets while maintaining a strong financial profile through the conservative use of debt and keeping its distribution well covered.

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By focusing entirely on operating fee-based assets, typically signed to long-term minimum volume contracts, Phillips 66 Partners generates very steady cash flow. Because of that, each new asset added to its portfolio increases the company's cash flow stream. Meanwhile, the company typically retains between 10% to 30% of its cash flow, which it reinvests in growth initiatives such as acquisitions and expansion projects. Furthermore, the company finances its remaining capital needs with a healthy balance of equity and debt. The evidence of that conservatism is its investment-grade credit rating and 3.8 times debt-to-EBITDA ratio, which is on the low end of its peer group. Because of these factors, the company's current 4.2% yield is on rock-solid ground.

Clearly visible growth

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Despite this conservative approach, Phillips 66 Partners has grown briskly over the past few years, primarily by acquiring midstream assets from Phillips 66. In fact, since its IPO, the company has increased its distribution by a 35% compound annual growth rate. Meanwhile, there's more growth up ahead since it expects to increase the payout by a 30% compound annual rate through 2018.

Three things will fuel that growth: organic expansions, dropdowns with Phillips 66, and third-party acquisitions. The company already has several growth projects under construction, including a partnership with Sunoco Logistics Partners (NYSE: SXL) and Energy Transfer Partners (NYSE: ETP) to build the Bayou Bridge Pipeline, which will connect to Phillip 66's expanding Beaumont Terminal. However, that is just one of several projects that the company expects to invest $381 million into this year.

Meanwhile, it will likely continue to acquire midstream assets from Phillips 66, which are a meaningful contributor to growth. Last year, for example, it spent $1.3 billion to buy 30 crude, products, and NLG logistics assets from its parent. These assets came with a 10-year terminaling and throughput agreements setting a volume floor at 85% of forecasted volumes, enabling the company to lock in roughly $150 million of annual earnings. That incremental cash flow allowed 5% distribution increases in each of the subsequent quarters. Meanwhile, despite already dropping down billions of dollars in assets to its MLP over the past few years, Phillips 66 still has several left to send down, including its 25% stake in the recently completed Dakota Access Pipeline operated by Sunoco Logistics Partners.

In addition, the company will continue to seek out third-party acquisitions to strategically expand its system. Last year, for example, the company acquired a natural gas liquids system in Louisiana from Chevron (NYSE: CVX). Not only will the assets provide it with about $25 million in fee-based earnings on an annual basis, but they came with clearly visible expansion opportunities to grow that fee-based cash flow stream in the future.

Investor takeaway

Phillips 66 Partners offers investors a rock-solid income stream, thanks to its focus on owning fee-based assets that generate consistent cash flow and its financially conservative approach. Meanwhile, the company has clear visibility to grow that income stream because of its three-pronged approach consisting of organic expansion, dropdowns with its parent, and outside acquisitions. Add it up and Phillips 66 Partners offers a sustainable income stream that's ideal for retirees.

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Matt DiLallo owns shares of Phillips 66. The Motley Fool recommends Chevron. The Motley Fool has a disclosure policy.