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Why master limited partnerships rely heavily on external financing

Ingrid Pan, CFA

Capital markets remain open, a boon to MLP growth (Part 1 of 3)

Master limited partnerships rely heavily on external financing to fund growth

Master limited partnerships, or MLPs, are specially structured entities that must pay out most of the cash they generate to unitholders. So MLPs rely especially on external funding sources (as opposed to internally generated cash) to execute growth projects and acquisitions, as they’re limited from keeping much cash on hand. Because of this, the state of the capital markets (which generally refer to the equity and bond or loan markets) is an important factor in determining whether an MLP can find the money to participate in growth-oriented activities.

Currently, the capital markets remain open

Largely, both the equity and debt capital markets remain open with cost of funds that are attractive. Due to this, master limited partnerships have continued to raise large amounts of capital to fund growth projects. Plus, with the cost of funds being relatively cheap, the M&A (mergers and acquisitions) market in the midstream space has been very active.

The above graph shows the current dividend yield on the Alerian MLP ETF, which is an ETF whose purpose is to track the Alerian MLP Index (a cap-weighted index of the 50 most prominent energy MLPs). Many view the AMLP as a proxy for the midstream MLP universe. The dividend yield is a rough measure of equity cost of capital. In the following sections, we’ll discuss the cost of equity for MLPs as well as the cost of debt.

Continue to Part 2

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