Holly Energy Partners' Earnings Seem Less Important Next to This Big Change

Markets Motley Fool

Holly Energy Partners (NYSE: HEP) has been a great long-term investment with a good track record of delivering a growing payout to shareholders on a routine basis. Over the past few quarters, though, management has started to realize some of the things that made it successful in the past could be a hindrance in the future, so it decided to act sooner than later with a major ownership change between it and its parent company, HollyFrontier (NYSE: HFC).

Continue Reading Below

Let's look at the company's most recent results and what this change could mean for investors.

By the numbers

Metric Q3 2017 Q2 2017 Q3 2016
Revenue $110.4 million $109.1 million $92.6 million
EBITDA $75.0 million $75.0 million $64.7 million
EPS $0.66  $0.36 $0.33
Distributable cash flow $59.2 million $60.9 million $49.2 million

When compared with the prior year, Holly Energy Partners delivered higher results across all of its various reporting segments, except for its crude pipelines segment, whose performance was related to a one-time charge related to crude gathering assets. Other than that, results looked pretty good. Higher volumes across its system and the addition of the Woods Cross refining units led to a 19% increase in revenue and a 20% increase in distributable cash flow. As has been customary recently, management announced another 8% increase to its distribution. This was the 52nd consecutive quarterly increase. 

Regarding Holly's business activity, the company announced that it acquired the remaining interest in two pipelines: its Frontier and SLC pipelines. Before the announced deals, it owned 50% of the Frontier pipeline and a 25% stake in SLC. The cost for the two was $250 million in cash. Those acquisitions have not yet closed, but management expects to complete them soon. 

Continue Reading Below

Extreme makeover: ownership structure edition

For the past few quarters, management has said it was planning to address Holly Energy Partners' ownership structure, and the incentive distribution rights (IDRs) HollyFrontier held. Those IDRs -- a management fee, if you will -- made Holly Energy Partners' cost of capital too high to do deals and to grow organically. This was less of an issue when HollyFrontier had several assets it could drop down to its subsidiary. Those opportunities are fewer and farther between, though, and something needed to be done.

Management delivered on its promise this past quarter by changing the ownership structure. HollyFrontier exchanged its 2% general partner units and its IDRs for 37.25 million limited partner units -- the ones that are publicly traded. The parent company will also waive $2.5 million of its distributions per quarter for 12 quarters to help facilitate the deal. According to management, this will lower the company's cost of capital from 11% to 7% and will bring management's objectives more in line with public shareholders.

What management had to say

Here's what CEO George Damiris had to say about the most recent quarter. I should mention that the company closed the general partner and IDR swap shortly after this press release went out. 

We are pleased with our solid financial performance in the third quarter, which allowed us to maintain our record of continuous quarterly distribution increases and achieve our distribution growth target of 8%. We expect to complete our previously announced acquisition of the remaining interests in SLC and Frontier pipelines, which supply crude to refineries in the Salt Lake City area, very shortly.

We also plan to close on our announced agreement with our general partner to eliminate the incentive distribution rights held and convert the 2% general partner interest in HEP into a non-economic interest very shortly. Eliminating the general partner's IDRs and the economic GP interest will strongly enhance Holly Energy's ability to pursue growth opportunities and manage its business over the long term by decreasing its cost of capital.

Looking forward, we will continue to leverage our talented employee base, our relationship with HollyFrontier and our Mid-Continent, Northwest, and Southwest logistics footprint to generate new organic and external growth opportunities.

What a Fool believes

Holly Energy Partners' cost of capital has been a hindrance on the company's growth opportunities for a while. Now that this interest swap is out of the way, it should make it considerably easier for management to pursue new opportunities. 

The next step will be to identify those new opportunities. Growing through acquisitions can always be tricky because it's hard to find assets that fit its existing portfolio and sell for a reasonable valuation. Its best bet, which management has identified, is to grow organically in the Permian Basin through gathering and distribution pipelines for its Navajo refinery complex. If it can develop around this region with the same capital allocation prudence management has shown in the past, the company should do just fine. 

10 stocks we like better than Holly Energy Partners
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Holly Energy Partners wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of October 9, 2017

Tyler Crowe has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.