Master limited partnerships are not like other stocks, and the metrics we use to compare an MLP to its peers differ from the metrics we use to compare regular companies. For example, instead of the traditional P/E ratio, we emphasize MLP-specific metrics like distribution coverage ratio and today's focus: price to distributable cash flow (P/DCF). I'll use Enterprise Products Partners (NYSE: EPD ) , Kinder Morgan Energy Partners (NYSE: KMP ) , and Buckeye Partners (NYSE: BPL ) to illustrate the concept.
Why this metric?
Price to distributable cash flow is the MLP metric that comes closest to the P/E ratio most investors know and love. Like any good ratio, it allows you to compare MLPs on a relative basis, regardless of size.
Distributable cash flow per unit replaces earnings per unit in these relative valuations because MLPs pass almost all of their cash to unit holders. Distributable cash flow drives distribution growth, which in turn drives unit prices. That's really what investors care about the most with MLPs, and that's why analysts and management never discuss earnings per share for their MLPs; it's all about distributable cash flow.
How the metric works
To calculate P/DCF, you take the market cap of your MLP and divide it by a full year of distributable cash flow.
Let's use Enterprise Products Partners as our first example. We'll use distributable cash flow numbers from the four most recent quarters. The numbers shake out like this:
| $1,069 | $1,021 | $908 | $925 | $3,922 |
Source: MLPData.com, Yahoo! Finance. Dollar figures are in millions.
Now we'll divide the partnership's market cap by its distributable cash flow total of $3.9 billion to derive our P/DCF multiple:
| $68.1 | $3.9 | 17.4x |
Source: MLPData.com, Yahoo! Finance. Dollar figures are in billions
A multiple of 17.4 is a tad high, but we'll get to that in a minute. The whole point of this exercise is relative valuation, so let's see how Enterprise's multiple compares to that of some of its peers.
The DCF numbers for Kinder Morgan Energy Partners and Buckeye Partners come from the same four quarters that we used for Enterprise.
| EPD | $68.10 | $3.9 | 17.4x |
| KMP | $34.45 | $2.4 | 14.4x |
| BPL | $9.04 | $0.5 | 20.0x |
Source: Company releases, Google Finance. Dollar figures are in billions.
Enterprise falls right in the middle here. Given its recent trading history, it's not that big of a surprise to see Kinder Morgan posting the best multiple of the group. Its shares have vastly underperformed its two peers over the past year. Kinder Morgan is down more than 13%, while Enterprise and Buckeye Partners are up 19% and 16%, respectively.
But what is the benchmark for this cash flow multiple anyway? Most investors have heard that a P/E ratio greater than 15 is high, and the further it floats above that magic number the more overvalued the stock is. According to analysts at Morgan Stanley and Wells Fargo, the average multiple for large cap MLPs like today's group has been between 15 and 16 times price to distributable cash flow.
By this standard, Kinder Morgan is the only MLP here that is "cheap." But again, the P/DCF ratio is useful for relative valuations, but by no means would you want to base your entire investing thesis on this one metric -- or any one metric -- alone. Rather, it serves as a starting point for further research.
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