One of the most anticipated master limited partnership (MLP) offerings of the year debuts this week. Shell Pipeline Company (SPLC), a midstream subsidiary of Royal Dutch Shell (NYSE: RDS-A) recently formed Shell Midstream Partners (which will trade as SHLX), and units are expected to price late on Oct. 28 with trading kicking off the next morning.

Shell Midstream Partners intends to grow by acquiring more of Shell’s extensive portfolio of midstream assets, investing in expansion projects and potentially pursuing strategic acquisitions of assets from third parties. Most future growth will probably come from further dropdowns of Shell’s midstream assets.

The impending IPO was covered in some detail in the Aug. 11 issue of MLP Profits (“Shell Sells Pipelines by the Seashore.”) With this offering, Shell becomes the first major integrated oil and gas company to launch an MLP. Initial assets of Shell Midstream Partners will include interests in two refined products pipelines and two crude oil pipelines:

• A 49% interest in Bengal Pipeline Company, which owns a refined products pipeline that connects four refineries in Louisiana

• A 1.612% ownership interest in Colonial Pipeline Company, which runs a major finished product line connecting the Gulf Coast to the East Coast

• A 43% interest in Zydeco Pipeline Company, which will own the Houston-to-Houma crude oil pipeline system

• A 28.6% interest in Mars Oil Pipeline Company, which owns the Mars crude oil pipeline

The Bengal Pipeline is operated by SPLC and connects four refineries in Louisiana with the Plantation and Colonial pipelines, providing market outlets to the East Coast. Colonial Pipeline Company (Colonial) operates the largest refined products pipeline in the United States, traversing 11 states across the southeast and eastern seaboard. Colonial transports more than 100 million gallons per day of refined products, or approximately 50% of refined petroleum products consumed in the East Coast region of the United States, through its 5,500-mile system.

Zydeco Pipeline Company (Zydeco) is currently owned by SPLC. Zydeco will own the Houston-to-Houma Louisiana crude oil pipeline system (Ho-Ho). The Mars Oil Pipeline Company (Mars) operates a major crude oil pipeline in the offshore Gulf of Mexico, originating approximately 130 miles offshore and terminating in salt dome caverns in Clovelly, Louisiana.

The IPO aims to raise approximately $750 million with 37.5 million shares priced between $19 and $21, which would provide an annualized yield of 3.25% at the midpoint. The most recent market talk had shares pricing at $22 or higher.  

While that would push prospective yield below 3%, Shell has a very large portfolio of midstream assets that can drive the growth of the partnership for many years to come. Demand for this IPO is expected to be strong, so expect an opening well above the indicated price range. This will likely be a good long-term portfolio holding for MLP investors, but it is much more appealing for the potential capital appreciation than for investors seeking income.

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Portfolio Update

SHLX: Expensive, But Worth It

Can you afford to own Shell Midstream Partners (NYSE: SHLX) at 28 times annualized distributable cash flow, which is where it would trade at the midpoint of its preliminary pricing range? The answer is likely Yes for anyone who’s been an MLP investor for any length of time, since the sector continues to produce strong returns despite the lofty earnings multiples.

The more relevant question is whether you can afford not to own SHLX, the first midstream MLP spinoff by an oil supermajor, at 35 times DCF or more, which is where it is very likely to trade on day one tomorrow. And here the answer, for us, is No; Royal Dutch Shell’s (NYSE: RDS-A) huge base of premium, strategically located midstream assets will likely make SHLX a must-own for most MLP fund managers. Its combination of aggressive growth plans and conservative financial metrics (targeted 1.1x coverage; no debt and $100 million in cash following the IPO) will likely appeal to many individual investors as well.

The Ho-Ho crude pipeline that will initially supply the bulk of the MLP’s cash flows has become a crucial outlet for the Houston crude glut, connecting the booming Texas and North Dakota crude production to the huge Louisiana complex of refineries. The offshore Mars pipeline is poised to benefit from a drilling spree off the Louisiana coast that could spark big output gains,  along with larger and more lucrative Mars pipeline flows. The sliver of the Colonial fuel pipeline is the icing on the cake; a reminder of other gems in Shell’s midstream portfolio. These include chemical pipeline assets that will become increasingly valuable as new plants are built along the Gulf Coast.

We’ll be adding Shell Midstream Partners to the MLP Profits Growth Portfolio at its closing price for the first trading session, which is highly unlikely to mark anywhere near the top for this security. Buy SHLX below $29.           

— Igor Greenwald