As we saw in our last post, Distributable Cash Flow is the amount of cash an MLP could pay out to investors in a given period. However, a well managed business balances future cash requirements with giving investors a return on investment today. As a result, not all DCF is paid out to unitholders – some is retained to fund expansion or to ensure that the partnership does not have to reduce distributions in the future.
As an investor, this is what we want – a business which generates more cash than required to provide investors a solid ROI. We can measure this with a metric called the “Coverage Ratio”:
In general, we want DCF to be about 1.2 times the amount of the actual cash distribution. In other words, DCF should be about 120% of distributions.
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