Holly Energy Partners (NYSE: HEP) has increased its distribution every quarter for 50 consecutive quarters. It offers a yield of more than 7.3%. Those are both impressive numbers that should catch the attention of any income-focused investor. That high yield, however, is partly because the market is concerned about Holly's debt load. Only that's not the metric that expert investors are watching.
A heavy load
Long-term debt makes up around 70% of Holly Energy's capital structure. That's a lot of debt when you consider midstream industry heavyweight Enterprise Products Partners' (NYSE: EPD) long-term debt stands at closer to 50% of its capital structure. Now add in the fact that Holly Energy is a tiny $2.2 billion market cap company compared to Enterprise's nearly $60 billion market cap. Small and heavily in debt -- not a great combination.
That helps explain why Holly Energy yields 7.3% compared to the 6% offered up by Enterprise. But the interesting thing is that both of these midstream players have a similar streak going. Enterprise has increased its distribution for an impressive 52 consecutive quarters, leading fellow Fool Matthew DiLallo to describe the partnership as a "dividend investor's dream." But Holly Energy isn't far behind, having increased its distribution for 50 consecutive quarters. It may be relatively small, but it's holding its own with an industry leader on the distribution front.
If not debt, than what?
There's no doubt about it: Debt is a concern at Holly Energy. But to help explain why it isn't the number that experts are watching, you need to dig a little deeper. At the end of 2013, long-term debt weighed in at roughly $807 million. Its debt load increased in each of the next three years, reaching more than $1.2 billion by the end of 2016. In three years, Holly Energy's debt increased by nearly 50%. The partnership's interest costs ate up around 13% of revenue last year. For comparison, Enterprise's interest expense amounted to just around 4% of revenue in 2016.
So debt really is a big deal. But you have to understand what that debt was used for. In this case it helped pay for acquisitions to grow Holly Energy's business. For example, Holly Energy's revenue grew roughly 30% between 2013 and 2016. That's a direct result of the new assets the partnership acquired with the debt it took on. Its business, meanwhile, is 100% fee-based with 80% supported by long-term contracts. With regularly recurring income, Holly Energy's business can support a heavier debt load while it grows.
Which is why the number to watch is the debt-to-EBITDA ratio. That number is a little high today, but if you look back at the partnership's history, there's nothing odd about that. Holly Energy has gone through several periods in which debt-to-EBITDA ratio has gone up due to acquisitions and it has worked the metric back down over time as it absorbed the purchase. It's just how the partnership grows, and management is comfortable with the process.
That doesn't mean you should ignore the impact of the debt Holly has taken on, but you shouldn't get overly concerned by the absolute number -- it's the wrong metric.
Watching debt in a different way
If you're considering an investment in Holly Energy Partners, remember that the experts aren't looking at the company's heavy debt load. They're watching the debt-to-EBITDA ratio to make sure Holly Energy starts to bring that number back down now that it's completed some big purchases. That's what you should be doing, too -- and perhaps collecting that 7%-plus yield and growing distribution while you do.
10 stocks we like better than Holly Energy PartnersWhen 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 July 6, 2017