2023-06-21 03:47:40 ET
Summary
- Holly Energy Partners L.P. offers a high-yielding dividend aristocrat, with a solid position in the oil and gas industry.
- HEP's financials are strong, with manageable debt and a debt/adjusted EBITDA of 3.75, supported by contracts with HF Sinclair.
- The company's valuation remains in line with the sector, making it an appealing buy for investors seeking exposure to the energy sector and a solid dividend yield.
Investment Summary
One of the appeals of Holly Energy Partners L.P ( HEP ) for investors is the yield it has right now. I think the company would suit a well-diversified portfolio very well as a high-yielding dividend aristocrat. The company has built up its business to a state where a yield like this is sustainable as cash flows have been consistent.
Besides that, the $1.5 billion amount in debts might seem frightening but the earliest maturity isn't until 2025, and even then, the cash flows should, if they stay the same, be sufficient to tackle it. The management remains adamant about keeping a solid dividend yield and anticipates they will maintain a quarterly dividend of $0.35 per share for the near term as they focus energy on growing cash flows further. This all accumulates to HEP looking like a solid opportunity to benefit from both a high dividend but also the oil and gas industry continuing to rise.
Oil Industry Remains Solid
Oil continues to play a vital role in our societies for several reasons, despite ongoing efforts to transition to cleaner and renewable energy sources. Its significance stems from its diverse applications and widespread use across various sectors. The demand is continuing and prices seem to somewhat stabilize too.
First and foremost, oil remains crucial in transportation. It fuels cars, airplanes, ships, and trucks, forming the backbone of our global transportation systems. The infrastructure and efficiency of these systems have been built around oil-based fuels such as gasoline, diesel, and jet fuel. Moreover, oil is a key raw material in numerous industrial processes. It is used in manufacturing plastics, chemicals, lubricants, and asphalt, among other products. These materials are essential components in industries ranging from construction and agriculture to pharmaceuticals and packaging.
As a midstream subsidiary to HF Sinclair (DINO), HEP has much more reliable financial performance and with the established position that DINO has, HEP will benefit from it in the long run heavily. Stability like that is worth a premium and right now the market values HEP in line with the sector.
The steady demand for oil is a tailwind for DINO too as they operate in the same industry. This tailwind will help ensure that HEP maintains solid cash flows going forward. With the average remaining length of contracts with DINO being around 5 years, and the length of them typically being between 10 -15 years there will be some renewals coming, most notably in 2024. The contract renewal here is expected to be just under $90 million and will help strengthen the operating cash flows of HEP further.
Risks
The market environment right now seems to be stabilizing somewhat and HEP has set itself up in a good position as its earliest debt maturities aren't until 2025. That means they should be able to consolidate during this time and build up a strong cash position to help battle the coming debts. If they would have had earlier or larger amounts of debt than the $1.5 billion they have, the current HEP could prove to be too risky.
The banking crisis we had earlier in the year did cause havoc in the markets and thankfully HEP has no immediate need for the capital markets. But if they had earlier debts, or the banking crisis resurges then I think access could be limited and present risks if HEP is needed to raise capital.
Financials
Moving over to the financials of HEP they remain quite strong. The earliest debt maturities as we have discussed are in 2025, and right now the long-term debts sit around $1.5 billion. Comparing the cash to debt would paint a very damming picture as the $7 million in cash would do little impact. But as levered cash flows have remained steady over the last few years, I think debt seems manageable.
As HEP is prioritizing distributing cash flows to shareholders they can't have any issues on the balance sheet as that would interfere with both the dividend and the buyback plans. As they are supported by DINO with contracts and ensuring cash flows the benefits shareholders can get here seems sustainable. 2022 was even a record-breaking year in terms of operating cash flows, likely driven also by the high oil prices for 2022 which helped fuel capital circulation in the industry. The company maintained optimistic about the outlook regarding the dividend and raises to it seem likely.
HEP is still maintaining a solid capital structure and with a debt/adjusted EBITDA of 3.75 I think it's at a decent point right now. Normally I would be worried about a company having a ratio above 3, as the likelihood of dilution as a means to raise capital grows. But given that HEP has a solid source of cash flows the higher ratio doesn't bring any concern. As mentioned before, comparing just the debt to the cash seems unfair, but the company actually has a strong amount of liquidity right now, nearing $550 million. That should be sufficient to battle any coming debt in 2025 in my view.
Valuation & Wrap Up
HEP is an interesting play as it offers investors a solid dividend yield that doesn't seem to hurt the quality of the company. The dividend is supported by strong operating cash flows as contracts with DINO, as signed continuously which helps ensure future revenues.
The share price has rallied over the last month or so after a steep decline. A month ago it would have been a solid buy, but I still find it appealing. The p/e remains in line with the sector so I don’t think you are necessarily overpaying for HEP right now. As a dividend addition to a portfolio lacking exposure to the energy sector, it has great potential. Going in the remaining half of the year keeping an eye out for HEP continuing to raise the dividend is key. In the meantime though I will be rating HEP a buy.
For further details see:
Holly Energy Partners: High Yield But Sustainable