Over the past two weeks, I have provided general overviews of two giant midstream MLPs in Plains All American Pipeline LP (NYSE: PAA) and Kinder Morgan Energy Partners LP (NYSE: KMP). Today I shift gears and take a look at a tiny downstream MLP in Lehigh Gas Partners LP (NYSE: LGP), which went public less than a year ago (October 2012).

Lehigh Gas Partners is a wholesale distributor of motor fuels to gas stations, truck stops, and toll road plazas in the United States. The company works with several major filling station brands, including ExxonMobil, BP, Shell, Chevron, Sunoco, and Valero.  LGP is one of ExxonMobil’s (NYSE: XOM) largest distributors in the United States and is a top 10 distributor for many other brands.

The company also owns and leases real estate used in the retail distribution of motor fuels. Lehigh Gas Partners properties include more than 500 sites in nine states: Pennsylvania, New Jersey, Ohio, Florida, New York, Massachusetts, Kentucky, New Hampshire and Maine. Of these states, five are among the top 10 consumers of gasoline in the US and four are among the top 10 highway diesel consumers. At year-end 2012 more than 85 percent of LGP’s sites were located in high-traffic urban and metropolitan areas. The partnership believes that limited availability of undeveloped real estate in its areas of operation presents a significant barrier for competitors in this highly fragmented business.

In its 2012 annual report, LGP highlighted the business strategies it believes will enable it to make increasing quarterly cash distributions to unitholders:

• Own or lease sites in prime locations and seek to enhance the cash flow potential of these sites

• Expand within and beyond core markets through acquisitions

• Serve as a preferred motor fuel distributor and provide dedicated supply and services to our customers

• Increase our wholesale motor fuel distribution business by expanding market share

• Maintain strong relationships with major integrated oil companies and refiners

• Manage risk by outsourcing delivery of motor fuel, mitigating exposure to environmental liabilities and implementing systems and controls to manage operations

The partnership sees recurring rental income and the consistent demand for motor fuel at its locations as guarantors of  stable cash flow. While LGP is exposed to some risks on the demand side, the partnership has historically purchased and delivered motor fuels on the same day to minimize commodity price risk.

Also working in LGP’s favor is that the major integrated oil companies continue to exit the retail fuel business, which opens up more opportunities for wholesale fuel distributors.  

Following its most recent quarter, LGP declared a second-quarter distribution of $0.4775 per unit, a 5.5 percent increase over the previous quarterly distribution of $0.4525 per unit. Compared with pro-forma second quarter 2012 results, LGP increased fuel distribution by 4.4 percent, increased gross profit by 12.1 percent, and pushed adjusted EBITDA to $11.1 million, a 34.1 percent increase. Based on LGP’s distributable cash flow of $0.75 per common unit, its coverage ratio on the second quarter distribution was approximately 1.6.

Last month LGP announced that it had acquired 30 key sites and four leasehold properties, along with seven third-party supply contracts and other assets associated with the sites, in and around Knoxville, Tennessee.

In August the partnership also announced an agreement to purchase 14 fee and three leasehold sites from Rogers Petroleum, Inc. These sites are located in eastern Tennessee, with a concentration in the Tri-Cities area.

Another positive sign is that insiders are buying. In the past month four different insiders have bought units, while none have sold. Three of the four purchases increased the holdings of the insider by more than 10 percent. LGP’s total insider ownership is 15.9 percent.

Lehigh Gas Partners isn’t your traditional MLP, and has risks and opportunities that are different from the midstream behemoths. But units have returned 32 percent since the October 2012 IPO. The current unit yield is 7.1 percent.

Summary

The annual distribution rate has increased 9.1 percent in the 10 months since the IPO, and is likely to continue to climb, because this is an aggressive serial acquirer that has set itself the goal of doubling in size within the next two or three years. That’s likely to distort quarterly comparisons from time to time, and should keep debt high relative to cash flow.But so far the operating results have been quite good, and widespread insider buying at the current price is an excellent sign for the future. The current yield fairly compensates investors for the risks, and provides some diversification from the midstream MLPs that make up the bulk of the space, with less commodity and execution risk than most upstream partnerships. We’ll be monitoring LGP’s progress closely.   

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

A Yield Forgiving of Bad News

Lehigh and Kinder Morgan (NYSE: KMI), the subject of last week’s update, are not the only MLPs attracting insider buying near current levels. Refiner and recent Aggressive Portfolio addition CVR Refining (NYSE: CVRR) saw chairman and majority owner Carl Icahn boost his stake by 50 percent to a total of six million shares during the second quarter, based on the most recent filing.

The famed investor paid significantly more than units now fetch, after a summer-long slide on concerns about the industry’s diminished profitability. But the spread between Brent and WTI crude that serves as a rough guide to refining margins has widened again of late in a positive sign for CVRR.  

Another good omen: the unit price proved resilient even after the partnership warned last week that a planned overhaul of the fluid catalytic cracking unit at its Coffeyville, Kansas refinery would take longer than expected, curtailing the partnership’s previous quarterly throughput forecast by roughly 15 percent. But CVRR reaffirmed the reduced annual distribution outlook provided at the time of the last report, and on that basis the projected yield remains at 15 percent at the minimum. That’s a prospective return well worth the refining industry’s notorious volatility, especially now that expectations have been reset. Continue buying CVRR below $28.