Making Sense of the Rally
The past 18 months have been challenging for MLP investors. But we mustn’t lose sight of the fact that the objective is to buy low. That means shopping while sector sentiment is weak (hence the low prices). So today I want to step back and take the long view on the sector’s performance over the years — which I believe shows that today’s prices reflect strong buying opportunities.
Consider the historical performance of the Alerian MLP Index, which provides a good measure of the overall health of the MLP sector. It is a composite of the 50 most prominent energy master limited partnerships accounting for approximately 85% of the MLP sector’s total float-adjusted market capitalization. The index is disseminated on a price-return basis (AMZ) and on a total-return basis (AMZX).
At present, the top 10 constituents of the AMZ are:
Before the 2014 downturn, the AMZ had significantly outperformed the S&P 500 for more than a decade. From 1996 until 2001, the S&P 500 was the better performer, but between 2001 and 2014 the AMZ opened up a significant performance lead. Only once prior to the 2014 correction had the AMZ pulled back to the historical performance level of the S&P 500, but shortly after that 2008-9 correction the AMZ again began to substantially outperform the S&P. The chart below shows the price return of $100 invested in these indices on Jan. 1, 2006.
The current correction has now dropped the AMZ well below the 20-year performance of the S&P 500, but a different picture emerges if we look at the total return (i.e., including dividends and distributions over that time). The annualized yield of the AMZ over that time frame has tended to be in the 6-8% range, while the S&P 500 was typically at or around 2%. That makes a big difference to the return over time:
In this case, it becomes clear that despite the large correction, an investor would still have been substantially better off in the AMZ over the past 20 years. This is small comfort to investors who first invested in the sector three years ago, but corrections like this create opportunities. The MLP sector is cheaper than it has been in years, but it isn’t likely to remain this cheap for long.
As I pointed out in December in The Loud Message of Fat Yields, whenever the AMZ yield has risen above 10% in the past it subsequently proved to have been a good buying opportunity. When the AMZ yield exceeded 10% in December 1999, the next 12 months saw a total return of 46%. When the yield rose above 10% in December 2008, the following 12 months notched a total gain of 76%. In mid-January and mid-February of this year, the yield rose above 10%, but it has since pulled back to 8.7% as the sector has rallied.
If history is any guide, today’s MLP prices signal a buying opportunity that only presents itself every few years. But some MLPs are in better shape than others at this stage of the energy bear market. Join us at MLP Profits to find out which MLPs are likely to outperform as the sector rallies.
Buying TerraForm Gloom
One way or the other, the end is likely nigh for the notorious renewable energy developer SunEdison (NYSE: SUNE). Its riches-to-rags story got a little shabbier still Tuesday on a report that SunEdison was in talks on debtor-in possession financing, usually prelude to a bankruptcy filing.
The stock tumbled 26% on the news, and was down an additional 11% today in recent action. Whether or not the bankruptcy filing comes quickly, SunEdison’s status as a cash-starved developer of costly projects has become increasingly untenable. Last month, a Hawaii utility terminated power purchase agreements for three solar farms under construction by the company after SunEdison missed financing deadlines.
The prospect of going from a troubled sponsor to an insolvent one has also been hard on SunEdison yieldco TerraForm Power (NASDAQ: TERP), whose share price is down 17% since March 15 (and 78% in 10 months.)
It hasn’t helped that TERP has delayed the filing of its annual report as a result of an internal audit at SUNE tied to allegations made by former executives. While TERP shareholders have little to fear from this delay, it’s also caused the yieldco to defer “a decision on our 4Q 2015 dividend until we complete our annual financial statements and resolve other pending matters,” as TerraForm put it in the Feb. 29 press release.
I’ve argued before that TERP will be much more highly valued once it’s no longer controlled by SunEdison, and a bankruptcy filing by the latter would certainly be one way to get there. While delaying the dividend and framing it as a decision to be made is not a good look, TERP was set up explicitly to provide tax-deferred income from a portfolio of power supply contracts with investment-grade customers. This income stream would not be jeopardized by a SunEdison bankruptcy, nor can SunEdison capriciously stop it. Its control of, and minority stake in, TerraForm is SunEdison’s most valuable asset, and is highly likely to pass into cleaner hands in the not-too-distant future.
Which leaves us with the current 16% tax-deferred yield based on TerraForm’s last four quarterly dividend payments, more than twice that of yieldcos with better parents. This makes TerraForm a highly attractive and accretive acquisition for any number of rival yieldco sponsors.
It also now makes Aggressive recommendation TERP our #7 Best Buy below $10.
— Igor Greenwald