Small-Cap Arc Logistics Partners Combines 8%+ Yield with Deep Pocketed Sponsors For Growth
I have written the following article for publication on the Seeking Alpha website. Since ARCX is a Dividend Hunter portfolio recommendation, I am sharing the article exclusively with my newsletter subscribers before it submit it to Seeking Alpha. As a Dividend Hunter subscriber, you get a two day first look at this article.
With the recent commodity and stock market value changes in the energy and MLP sectors, Arc Logistics Partners LP (ARCX) has not worked out quite as I expected when I first started following this small MLP. In the summer of 2014, Arc Logistics was just entering that period after its November 2013 IPO when an MLP starts to string together a couple of complete quarters, providing some initial visibility on cash flow and distribution growth. As a very small MLP with a $300 million market cap (at that time) ARCX was flying under everybody’s radar, and I hoped that an initial above average distribution growth rate would push the market to drive up the unit price.
Through the middle of 2014, Arc Logistics lived up to my expectations. The second quarter distribution was 15% annualized better than the first quarter payout and ARCX was sporting a 6.5% yield. That was a nice combination for an attractive total return outlook. For the third quarter, the distribution was increased by 2.5% or 10% annualized. From a small cap MLP, I was satisfied with the combination of a 6.5% or so yield and 10% distribution growth.
With the collapse in energy prices, the ARCX unit value followed the energy sector down. The unit price shed about 40%, dropping from a steady $25 to a volatile $16 to $19 trading range. At the end of January, Arc Logistics Partners announced its fourth quarter distribution at the same rate as the third quarter payment. I was very curious to learn what steps the company’s management team would take to respond to the changes in the energy sector. Also, as a new MLP, the company had not yet shown a history of how it would generate revenue and cash flow growth. Now with a major acquisition announcement and the year-end earnings release, a clearer picture of Arc Logistics Partners has emerged.
Acquisition Vehicle for Big Money Investors
Starting with its small size $250 million market cap it seems that the sponsor and major investors in Arc Logistics plans to use the partnership as the management vehicle for opportunistic midstream acquisition opportunities. The sponsor, Lightfoot Capital Partners is a private equity firm focused in the energy industry with heavy weight investors such as GE Energy Financial Services. The LP units are primarily in the hands of motivated investors. This fact was shown by having 4 out of 5 of the largest unit holders providing the $75 million of the common unit equity capital that will provide part of the funding of the deal.
The acquisition, which was announced three weeks before the Q4 earnings release and covered more below, shows the willingness of Arc Logistic’s sponsor and major investors to help the company make large capital investments in relation to its current small size. In the long run, this should also pay off for us regular, small fry LP unit investors.
Terminal Purchase to Boost Distribution Growth
On February 20, Arc Logistics announced an agreement to purchase a newly built barge and rail crude oil terminal in Joliet, Illinois for $216 million. The terminal will facilitate the unloading and distribution of Canadian heavy crude to go to Chicago area refineries. The deal will close in mid to late April when the terminal is completed to the satisfaction of Arc Logistics and the primary contracted customer. Arc Logistics will be a 60% owner of the terminal and GE Energy Financial Services will own the other 40%. The MLP will receive an annual management fee as well as its 60% share of the terminal earnings.
The terminal has a signed, multi-year contract with a major oil company that is forecast to generate $23 to $25 million of total annual EBITDA, based on the minimum throughput commitments agreed to by the primary customer. Once closed, the deal will be immediately cash flow per unit accretive. Management has stated that the quarterly distribution will increase to $0.44 per unit following the first full quarter (which would be after Q3) of operating the terminal. This will be a 7% increase in the distribution rate.
The facility has rail and marine access and capabilities and 80 acres of land available for future expansion. The terminal and land allow for significant opportunities for future growth capital spending.
Lumpy Growth Expectations with Attractive Current Yield
The new acquisition and management comments shows that Arc Logistics will not be one of those MLPs with steady distribution growth or one that increases the quarterly rate based on expected cash flow. Distributions will be paid on actual quarterly results. The company’s nationally diverse terminal business is about 75% take or pay contracts with an average 3 year contract length. These factors show that management is committed to distribution growth, but only when growth projects or acquisitions are completed and the cash flow is actually flowing.
The strong part of the Arc Logistics story is the willingness of large investors to partner with the MLP to make meaningful acquisitions or invest in growth projects. I like the idea of investing alongside of major investors who will use the MLP as a growth investment vehicle.
At the current $19.40 unit price and current distribution rate, ARCX yields 8.5%. The expected Q3 distribution rate puts the forward yield just above 9%. This is a volatile and thinly traded unit, so investors need to watch for entry points. The equity issuance to the large investors will be at $17 per unit, so the market price may drop below $18 when the terminal acquisition closes and is funded. With the high current yield and prospects for growth I like Arc Logistics as a long term hold, with an over time unit acquisition strategy.