Holly Energy Partners: Operational Excellence As Investment Thesis Strengthens

Investment Rundown

The natural gas and oil industry is certainly not going to run out of steam in the coming decades. The sheer amount of energy generated from these sources is almost hard to imagine. Even though more and more energy are being generated through renewable, there is still a significant market opportunity for companies like Holly Energy Partners, L.P. (NYSE:HEP) right now. The company has had its share appreciated by over 40% in the last 12 months with an FWD yield of over 6%.

Investors who managed to hit the bottom back in May have seen significant returns since then. I still think that the company exhibits a strong buying opportunity and given the current premium the company trades, I think is justified given the strong earnings growth and dividend it is capable of distribution to investors.

Company Segments

HEP is the proprietor and operator of a comprehensive network of pipelines transporting crude oil and refined products. Additionally, they oversee storage tanks and terminals, strategically positioned near or within HF Sinclair (DINO) refineries. These valuable assets are strategically located in regions with promising growth prospects, encompassing the Mid-Continent, Southwest, and Northwest areas of the United States.

The contracts that the company has set up with DINO are solid and have an average life span of 5 years right now, but the typical contract length is 10 - 15 years with DINO. This is enabling HEP to have steady and reliable FCF and yield investors with the dividend it currently has without risking overleveraging itself too much or taking on debt to fund it.

The majority of HEP income is derived from fee-based sources, and these revenues are minimally influenced by fluctuations in commodity prices. Notably, around 70% of the fees are secured through minimum-volume contracts. Under these agreements, customers are obligated to make minimum annual payments, irrespective of the actual volume of transportation and storage services they utilize. This dependable revenue structure provides stability and predictability to the company's financial performance, reducing its exposure to market volatility. This is a very strong and defensive business model to operate from and has led to strong margin retention over the years. With strong margins comes a great ability to sustainable yield investors with a good dividend. This is part of the reason I think for the premium the company is receiving currently based on earnings. But for those who seek a sustained high dividend yield, this is a premium worth paying hands down.

Markets They Are In

Given that HEP serves DINO and that their asset base is located near strong basins in the US the market opportunity you are getting with HEP right now is incredibly appealing. Whilst a lot of companies are seeing volatile margins as commodity prices fluctuate, the fact that HEP has this type of setup is enabling them to sustain through the cycles and deliver consistent growth as the revenues are fee-based. Some of the areas that are worth mentioning are the Southwest and Northwest of the US which offer strong growth and expansion opportunities for HEP.

Earnings Highlights

As we know, the revenues for HEP are largely fee-based so there shouldn't be a significant increase or decrease between the years for the company, but this reliability is why so many investors are flocking to it as well. Total revenues nonetheless grew nearly $4 million YoY but increases in the general and administrative expenses suppressed some of the earnings of the company. Interest expenses have also been a leading factor for the lower net incomes of the business. With this in mind, I think that HEP will do decently over the time of heightened interest rates, but once they go down, I can see the share price rallying to reflect the more optimistic outlook on company EPS. Over the last 12 months, the dividend the company has paid out is worth $177 million. With the last quarter yielding $73 million in distributable cash flows I think that HEP remains in a position where the dividend can be maintained and the risk of cutting it is very slim.

Risks

The current market environment appears to be showing signs of stabilization, and HEP has strategically positioned itself advantageously. Notably, the company's earliest debt maturities are not due until 2025. This favorable timeline allows HEP to focus on consolidation efforts, potentially building a robust cash position to address upcoming debt obligations. Had the company been burdened with earlier or larger debt commitments, its risk profile could have been considerably higher, potentially impacting its ability to navigate the current market conditions effectively.

In addition to the growing debt levels, there is another significant concern for HEP, unfavorable commodity prices. A downturn in commodity prices could potentially hinder the company's earnings growth, consequently limiting the amount of capital available for servicing its debt obligations. This double-edged challenge of mounting debt and volatile commodity markets underscores the importance of prudent financial management for HEP's long-term sustainability. Being mostly focused on oil and petroleum though, the recent surge in oil prices has likely been a big reason for the share price growing so quickly, but incidentally, this could reverse as well if the price of oil decreases as the two seem quite tightly knitted right now.

Final Words

The share price for HEP has increased a lot in just the last 12 months and the dividend yield sits at over 6% right now. For investors who seek a sustainable dividend-yielding oil company, HEP is perhaps one of the best in the industry right now. A large part of the revenues is fee-based so large amounts of fluctuations between the years are unlikely to occur. This makes the dividend sustainable and paying the current p/e premium for the company seems very fair. Concluding the article, I am rating HEP a buy right now.