EQT Midstream Partners LP (NYSE: EQM) went public on June 26, 2012, at the high end of its expected valuation range of $19 to $21, an indication of strong demand. Since the IPO, the stock price has trended steadily higher.
The MLP operates two business lines: transmission and gathering. The firm’s transmission segment, which accounts for about 85 percent of annual revenue, consists of a 700-mile, regulated interstate pipeline and 14 associated natural-gas storage facilities. The gathering business comprises about 2,100 miles of low-pressure gathering lines that connect individual wells to larger pipelines and processing facilities. All these pipelines are located in southern Pennsylvania and northern West Virginia, the heart of the Marcellus Shale.
EQT Midstream’s general partner and sponsor is EQT Corp (NYSE: EQT), an exploration and production company with a market capitalization of over $8 billion and operations in several unconventional plays. EQT Corp owns over half a million net acres in the Marcellus Shale, a region that contributes more than 40 percent of the company’s total production.
With more than 80 percent of its revenue backed by contracts, EQT Midstream has little exposure to fluctuations in commodity prices. Under these deals, producers pay a capacity-reservation fee to EQT Midstream regardless of how much gas they transport on the MLP’s pipelines. The contracts covering its transmission and storage business have an average remaining duration of 9.5 years.
The remainder of EQT Midstream’s revenue comes from interruptible service contracts. Under these deals, EQT Midstream earns a fee based on the volume of natural gas a producer ships on its gathering pipelines, a segment that accounts for less than 15 percent of the MLP’s annual sales. Note that the fees garnered by pipeline and gathering system operators aren’t directly tied to the price of natural gas. However, when the price of this fuel drops, producers tend to scale back drilling activity, reducing throughput on these systems.
EQT Corp accounts for about two-thirds of the gas transported across EQT Midstream’s assets. Although natural gas continues to fetch less than $3 per million British thermal units, the Marcellus Shale’s low production costs ensure that drilling in the play’s core remains economic in the current pricing environment.
The MLP also has considerable room for growth both organically and via drop-down transactions from its parent. EQT Corp has invested about $1.7 billion in midstream infrastructure over the past five years and owns a number of assets that would be suitable for the MLP, including more than 8,000 miles of gathering pipelines in the Marcellus Shale and the Utica Shale.
In addition, EQT Corp owns the 41.5-mile Sunrise Pipeline that’s currently under construction and slated for completion this quarter. Once this pipeline is up and running, EQT Midstream will lease the asset for up to 15 years and will have the opportunity to purchase the system when the agreement expires.
The fledgling publicly traded partnership has also identified several projects to increase its existing pipelines’ capacity and interconnections with other lines.
EQT Corp owns two-thirds of EQT Midstream’s outstanding common units and a general partner interest, giving the sponsor every incentive to ensure that the MLP grows its business and quarterly payout.
The MLP has set a minimum quarterly distribution of $0.35 per unit, and the general partner’s IDR payment amounts to only 2 percent of available cash for distribution up until holders of the common stock receive $0.4025 per unit. The IDR fee jumps to 15 percent of available cash when the regular quarterly distribution exceeds $0.4025 per unit, 25 percent when the disbursement to unitholders surpasses $0.4375 per unit and 50 percent for sums over $0.5250 per unit.
To ensure that the MLP at least meets its minimum quarterly distribution, the sponsor also owns 17.4 million subordinated units that won’t receive a distribution until holders of the common units have received their minimum quarterly distribution and any arrearage from prior quarters. The subordinated units convert to common units after June 30, 2015, or when the company has met its minimum quarterly distributions for three consecutive four-quarter periods.
EQT Midstream is a high-quality midstream MLP that boasts a strong sponsor and considerable distribution growth potential. Based on the partnership’s minimum quarterly payout, the stock yields 5.1 percent–near the low end of my coverage universe. But this below-average yield reflects the MLP’s stable cash flow and the likelihood of near-term distribution increases.