InvestingDaily.com

Account Information

  • My Account

    Manage all your subscriptions, update your address, email preferences and change your password.

  • Help Center

    Get answers to common service questions, ask the analyst or contact our customer service department.

  • My Stock Talk Profile

    Update your stock talk name and/or picture.



Close
FEATURED STRATEGY

This Two-Minute Market Move Could Make You Rich

This Two-Minute Market Move Could Make You Rich[Revealed] How to generate instant income from the stock market. Over and over again. At will. This technique is so powerful – and safe – we’re guaranteeing you can use it to generate $1 million (or more) in retirement cash. And we’ll even send you a $1,000 check to kickstart your journey. Go here for details.

 

Upstream Down the Drain

By Robert Rapier on March 30, 2016

One question that I have been asked on a regular basis — since almost the start of the decline in oil prices in 2014 — is whether it is time for investors to jump back into upstream (i.e., oil and gas production) MLPs. Today I want to emphasize the risks of these upstream MLPs as evidenced by some of their 2015 financial metrics.

Given the high risk, we don’t normally recommend the upstream sector for most MLP investors. On a historical note, when I started writing this newsletter both MLP Profits and The Energy Strategist recommended several upstream partnerships, including by far the largest of these, Linn Energy (NYSE: LINE). We kept Linn in the portfolios for a while, and investors who had held since the original recommendation more than doubled their money.

But we became increasingly concerned over a weakening cash flow position and an SEC investigation into its accounting, so on July 2, 2013 we issued a sell recommendation for Linn Energy. On that day Linn Energy units closed at $27.05. Today you could buy a unit of Linn for 35 cents. This should emphasize to investors the significant risks in the upstream MLP space.    

But since these producers are an ever-popular topic of inquiry with investors, today I want to list and compare them. For this exercise, I used a proprietary Excel-based screen that utilizes the S&P Global Market Intelligence database. I screened for publicly traded partnerships engaged primarily in upstream operations that reported at least some oil and gas reserves at the end of 2015. Most of these are engaged in oil and gas production, but two of them own mineral rights and rely on royalty payments for distributions. In order of descending enterprise value (EV), they are:

160330MLPIItable1

  • EV – Enterprise Value in millions of dollars as of March 29, 2016
  • EBITDA – 2015 earnings in millions of dollars before interest, tax, depreciation and amortization
  • FCF – Levered free cash flow in millions of dollars  for the trailing 12 months
  • Res – Total proved reserves in million barrels of oil equivalents (BOE) at year-end 2015

There are two significant items to note in this table. First is that a Debt/EBITDA level above about 3 is high. The higher it gets the more difficulty a company will have in paying off its debt. Companies like Linn Energy that have a Debt/EBITDA ratio above 6 will find increasingly limited options in managing their debt, and bankruptcy will loom as a realistic possibility. Don’t let Linn’s $9 billion EV mislead you into thinking otherwise.

In fact, the formula for calculating EV is to take the market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents. Much of the difference between a company’s enterprise value and its market capitalization is typically accounted for by its debt. Inclusion of debt provides a more accurate estimate of the cost of acquiring the company. In Linn’s case, its $9 billion of debt certainly matters a lot more than its $142 market capitalization in evaluating the partnership’s prospects.  

The second thing to note from the table is that the two MLPs based on mineral rights — Viper Energy Partners (NASDAQ: VNOM) and Blackstone Minerals (NYSE: BSM) — have very little relative debt. That is primarily because they don’t have the same operating expenses as the conventional oil and gas producers. As a result, they have held up better over the past year than the others. Here is the list again, highlighting some other important performance measures:

160330MLPIItable2

  • SM – Standardized Measure, the present value of the future cash flows from proved reserves as of year-end
  • Change = Year-over-year change in the standardized measure
  • 1 Yr Ret = Total unitholder returns for the past 12 months (except for Black Stone, which had its IPO in May 2015)

The first thing to note is the enormous year-over-year deflation in the estimates of future cash flows of these companies. To review, each year the Securities and Exchange Commission (SEC) requires energy producers to estimate the present value of the future cash flows from proved oil, natural gas liquids (NGLs) and natural gas reserves, net of development costs, income taxes and exploration costs, discounted at 10% annually. This calculation is called the standardized measure (SM), and is based on the average prices received over the past 12 months for oil, natural gas and natural gas liquids.

In total, between year-end 2014 and year-end 2015 these companies cumulatively reduced their estimated future cash flows by nearly $21 billion. Linn Energy took the biggest overall hit with a reduction of $9.5 billion. These reductions came about not only because the value of the reserves has dropped with oil prices, but also as some reserves were written off as uneconomical to produce at prevailing prices. Linn Energy, for example, had to reduce its estimate of proved reserves by nearly 40% from the prior year as a result of lower commodity prices.   

The second item to note on this table is that VNOM and BSM — again the only two MLPs on the list based on mineral rights — were the only ones not to lose at least 50% of their value over the past 12 months. This suggests that if you want some exposure to the upstream MLP space, this may be a less riskier alternative to the exploration and production MLPs.  

Nevertheless, we continue to recommend that investors avoid this space. The tables above highlight the high level of risk. Yes, when oil and gas prices ultimately rebound some of the names on the list will do quite well. But some others will likely be out of business.

And when MLPs go out of business their limited partners face losses beyond the worthless equity. That’s because the debt written off in a partnership bankruptcy is treated as taxable income accrued by the partners, even though these phantom gains don’t represent actual cash flow.  

If you really feel like gambling, why not join Igor, me, and the rest of the Investing Daily gang in May at our annual Wealth Summit conference in Las Vegas? We don’t recommend gambling, but your odds at the casinos will be better than with these upstream MLPs.

The Wealth Summit is a great way for us to meet subscribers one-on-one, and there are still spaces open if you’re interested. Also this year I’ll be making a special recommendation to those who attend the summit, and to those who are members of our Wealth Society. (WESO members receive all the Investing Daily newsletters and other premium services.)

For me it’s a fun exercise because there are no rules. I’m not bound to recommend energy stocks. Nor am I allowed to reveal the pick beforehand. But I’d love to discuss it with you in Las Vegas.

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

 

 


You might also enjoy…

 

Here’s What’s Really Going to Crush the Market

Most folks understand the basic concept of inflation… things cost more money. But tragically, most don’t understand the real implications of what it means for their financial future. 

Or just how dangerous it’s becoming right now. Today.

And there are two reasons for that…

First, the U.S. government’s calculations barely take into account two of the things you and I are paying more and more for every day: energy and food.

Second, since inflation really hasn’t been an issue for the past 30 years here in the U.S., most analysts won’t dare to say it’s on the rise because they’ll suffer professionally. 

But I’ve made a name for myself by always saying what needs to be said. Which is why I’ve prepared a new special report that’ll give you simple instructions on how to protect yourself from the coming storm.

And better still…

It gives you the full story on the six types of investments that are destined to soar 275%… 375%… even up to 575% over the next few years as the winds of inflation flatten the U.S. economy.

You can get your free copy here.

Stock Talk — Post a comment Comment Guidelines

Our Stock Talk section is reserved for productive dialogue pertaining to the content and portfolio recommendations of this service. We reserve the right to remove any comments we feel do not benefit other readers. If you have a general investment comment not related to this article, please post to our Stock Talk page. If you have a personal question about your subscription or need technical help, please contact our customer service team. And if you have any success stories to share with our analysts, they’re always happy to hear them. Note that we may use your kind words in our promotional materials. Thank you.

You must be logged in to post to Stock Talk OR create an account.

Create a new Investing Daily account

  • - OR -

* Investing Daily will use any information you provide in a manner consistent with our Privacy Policy. Your email address is used for account verification and will remain private.