Delek Logistics Partners (NYSE: DKL) is a three-quarters of a billion midstream company with assets focused in the United States. The company, headquartered in Tennessee, is the midstream arm of Delek US Holdings (NYSE: DK). As we’ll see through this article, the company’s continued midstream cash flow and dividend strength make it a strong investment.
For those interested in learning about Delek US Holdings, I recommend reading my deep dive article here. Those not currently subscribed to The Energy Forum can get a two-week free trial, with no risk and no charge.
Delek Logistics Partners Overview
Delek Logistics Partners is a small midstream company; however, that doesn’t mean that the company doesn’t have respectable assets or potential. We will start with an overview of the company.
Delek Logistics Partners Overview - Delek Logistics Partners Investor Presentation
Delek Logistics Partners has a distribution, that based on recent share price drops, is 11.47%. The company has achieved strong distribution growth annually, with 11.4% YoY growth. More importantly, the company has achieved strong coverage of this impressive dividend. Its coverage has expanded from 1.06x in 1Q 2019 to 1.11x in 3Q 2019. That’s on top of the rapidly growing dividend.
The company’s balance sheet has remained respectable - the company has $254 million in credit. Additionally, the company has a “leverage ratio of 4.6x;” it’s a respectable leverage ratio. For reference, Kinder Morgan (NYSE:KMI), one of the largest midstream companies in existence, has put its target leverage ratio at 4.5x. The company is focusing on “organic projects, supporting coverage and reducing leverage.”
To be fair, every midstream company in the world has those goals.
However, the company does have an impressive number of growth opportunities, such as the Red River and Paline Pipelines. The company’s Red River joint venture is a joint venture with Plains All American (NYSE:PAA), one of the largest midstream companies. The $144 million investment is significant for a $768 million company, but the post-expansion adjusted EBITDA in 1H 2020 is $23 million.
That’s ~10% growth in the company’s adjusted EBITDA annually - a significant project worth paying attention to. The company also achieved a Paline tariff increase that increased annual adjusted EBITDA of ~5%. These two benefits together can allow the company to increase its adjusted EBITDA by ~15%. Past this, the company also has Permian Basin pipeline growth opportunities.
Delek Logistics Partners Growth Opportunities
Now that we have an overview of Delek Logistics Partners, let’s discuss its growth opportunities in additional detail.
Delek Logistics Partners Drop down Opportunities - Delek Logistics Partners Investor Presentation
The Big Spring Gathering System, across the Permian Basin, and the Wink to Webster JV Pipeline represent massive opportunities for growth. The Permian Basin and the Texas coast represent the fastest-growing energy areas in the United States, with massive growth in midstream infrastructure. The Big Spread gathering system is a “200-mile gathering system, 350 Kbpd throughput capacity,” a large system.
The business connects to Delek US’ Texas terminal - showing integration throughout the system. The capital cost is ~$200 million from 2018-2019 and will continue to grow going forward. It supports Delek US while providing significant EBITDA growth.
Additionally, the company is working on a Wink to Webster JV pipeline, a massive “650-mile 36-inch diameter crude oil pipeline.” The pipeline will be completed in early-2021, supported by long-term commitment, and has >15% IRR. Dropdowns of these assets, with Delek US planning to double midstream EBITDA over the next 4 years, could provide Delek Logistics Partners with significant opportunity.
The picture is great. Delek Logistics Partners can comfortably cover growth, it has an incentivized sponsor that wants to drop down assets (and owns 63% of the company so it can benefit). Anytime it wants growth with strong returns, it can raise money and get the assets from that sponsor. But if it wants to keep debt low, it can slow down and keep supporting its strong dividend.
However, it’s worth noting Delek Logistics Partners has $254 million in liquidity and seems interested in spending that liquidity on new projects. It also seems interested in taking advantage of increased dropdown availability from its sponsor, with the aim of growing its dividend. As a result, I would expect some new deals to surface from 2020-2021, and it’s a catalyst to look out for.
All of this doesn’t include the fact that Delek US Holdings, the sponsor, is also a cash-flow powerhouse. You can read about that here.
Delek Logistics Partners Financial Strength
Delek Logistics Partners has strong financial strength and long-term contracts that support its cash flow.
Delek Logistics Partners Cash Flow - Delek Logistics Partners Investor Presentation
Delek Logistics Partners has long-term contracts with 52% having a 3- to 5-year contract and 20% having a >5-year contract. Just 27% of contracts have <1 year contracts. Additionally, 68% of the company’s gross margin comes from MVCs. That means that companies are effectively committed to paying the cash for the duration of these contracts.
It’s also worth noting that a significant number of the contracts are with Delek US Holdings, the sponsor, which has a strong financial position (~$140 million in net debt not counting Delek Logistics Partners’ debt). The company’s strong refining assets and commitment here (its P/E ratio is in the mid-single-digits, which you can read about here) mean that this cash flow is stable. More so, Delek US Holdings’ ownership of Delek Logistics Partners’ incentivizes it to pay these bills.
Delek Logistics Partners Financial Improvements - Delek Logistics Partners Investor Presentation
Delek Logistics Partners has continued to increase its net income and EBITDA to support rapid growth in distributable cash flow. The company’s dividend growth is phenomenal - it has gone up 28 times since the IPO over the past 7 years. The company’s dividend has gone up from $0.375/share to $0.885/share on a quarterly basis - double-digit annualized growth.
The company’s excess capacity on its revolver, as it continues to invest on drop-down assets, is strong. As we saw above, potential dropdown assets have an IRR >15%, while the company’s senior notes alone are paying 6.75%. That almost 10% difference can be translated to shareholder returns.
It’s also worth noting that this improvement in shareholder returns and dividends has come on the back of an improving coverage ratio. The company’s dividend averaged around $0.70/quarter in 2017 with a 0.97x coverage ratio increasing to $0.885 in the most recent quarter with a 1.11x coverage ratio. That’s a 25% dividend increase as the coverage ratio has increased 15% - a massive increase.
This indicates the company’s financial strength, its history of growth, and that potential going forward.
Delek Logistics Partners' Risks
Despite this, there are two major risks investors should pay attention to. The first is the risk of over-leverage as Delek US Holdings seeks to unhold assets. The second is the overall lack of diversity, which could be beneficial, but could also be a risk.
For the first risk, the risk of over-leverage, the company has ~$850 million of debt. This is larger than its market cap (~1.2x its market cap), which is normally a bad sign. However, it’s worth noting that the company has 1.11x distribution coverage with an 11.5% dividend yield, which also indicates that the company’s stock could potentially be undervalued.
However, potential additional dropdowns from Delek US Holdings could extend the company’s financial position further and put it in a difficult position. The company is planning to do these things, so it’s worth paying attention to. I don’t expect it to be a large risk, but its desire for dropdowns might sometimes cause it to raise capital in non-ideal ways. Non-ideal ways are ways of raising capital, like Occidental Petroleum (NYSE: OXY) did with Warren Buffett, and can cost shareholders significantly.
The second risk is an overall lack of diversity. The company is 63% owned by Delek US Holdings, it gets its dropdowns from Delek US Holdings, and it has a significant % of its assets contracted with Delek US Holdings. These companies are effectively tied at the hip, and as a result, Delek US Holdings is a significant influence. That can be good or bad, but it's a risk worth knowing.
Delek Logistics Partners has a double-digit dividend with a significant history of growth. The company has managed to grow its dividend by double-digits annually for the past 7 years. Specifically, in the past 2 years, in the midst of the oil crash, the company has increased its dividend by 25% with its coverage ratio by 15%. That’s a massive improvement in the financial position.
Going forward, Delek Logistics Partners has significant expansion potential. The company should see numerous dropdowns from Delek US Holdings and it has more than $250 million in remaining capacity on its revolver; with a market capitalization of ~$760 million, this is the chance for significant growth. For reference, the potential dropdown assets have a >15% IRR (meaning mid-single-digit overall company growth).
This indicates how Delek Logistics Partners is a strong investment.
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Disclosure: I am/we are long DKL, DK, OXY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.