MLP Metrics: The Coverage Ratio

We recently posted an entry outlining the importance and calculation of distributable cash flow (DCF) when evaluating MLPs.  In a nutshell, DCF represents what the MLP could have paid out in cash to unitholders had it chosen to do so.  However, while investors want to see cash distributions grow over time, they also want to see the MLP managing cash responsibly as well.  That is, they want to feel confident that the firm is maintaining reasonable levels of cash “coverage” so it can continue to grow the business moving forward.  The “coverage ratio” is the de facto standard for measuring this and is calculated by:

Typically, investors want to see a coverage ratio of anywhere from 1.2 to 1.5 in addition to growing quarterly distribution payments.