The Case for MLPs
In this issue:
It’s far too early for anyone but the doomsayers to say anything like we told you so, even after the 50% bounce in oil prices from the February lows and a 29% snapback by MLPs. After all, the Alerian MLP Index remains down 10% year-to-date and a dizzying 52% from its 2014 peak.
But, leaving the price action aside, things have gone about as well as could be expected under the circumstances. By and large the midstream cash flows have held up, propped up by contract guarantees that have proven reliable, if not quite foolproof. Aggregate volumes of oil, gas and fuel shipped by pipe have continued to rise, boosted by rising domestic energy demand and the surprising resilience of shale producers.
The changes on the ground simply can’t account for market discounting, and the sector’s sharply higher yield is merely the most obvious indication of that. As our lead story notes, a double-digit yield on the Alerian MLP Index like the one we saw two months ago has in the past presaged much bigger and longer rallies than the recent one we’ve seen.
History doesn’t have to repeat of course, but it often rhymes and there’s no reason to believe that either a) America’s energy consumption and midstream infrastructure are in decline or b) that double-digit tax-deferred yields will stick around indefinitely. That being the case, we can only conclude that sooner or later the yields will decline more by means of further capital appreciation.
As the accompanying portfolio update shows, most MLPs continue to increase distributions. The notable exception is Energy Transfer Equity (NYSE: ETE), whose finances and valuation have been badly strained by a costly merger bid. But whether or not the merger goes through, and whether or not the distribution is ultimately cut to ward off a credit downgrade, it seems clear to us that the market is drastically undervaluing ETE’s long-term profitability and growth opportunities.
We’re also adding a new MLP to the portfolios this week, but it’s not a traditional one shipping crude or processing natural gas, Rather, it’s a supplier of wood pellets enjoying a boom as a coal substitute in Europe and parts of Asia. As with all our recommendations, we evaluated this one as a business rather than a yield. But we’re not blind to the likelihood it should end up distributing close to 10% of its current price this year on tax-advantaged terms. Over the long haul, these things matter.
There’s nothing better than buying into an elevated yield that sticks around and works its compounding magic in the course of years. We’re not done sifting through the discount bin.
- Capital Products Partners (NASDAQ: CPLP) downgraded to Hold in Aggressive Portfolio
- Enviva Partners (NYSE: EVA) added to Aggressive Portfolio; buy below $23
- EQT Midstream Partners (NYSE: EQM) upgraded to a Buy below $80 in Conservative Portfolio
- Global Partners (NYSE: GLP) downgraded to Sell in Growth Portfolio
- Targa Resources (NYSE: TRGP) downgraded to Sell in Growth Portfolio
Oil prices seem to be finding some support near $40/bbl, but many experts fear the rally will soon fizzle given the high levels of global crude inventories. Since our previous issue West Texas Intermediate (WTI) rose $2.72 to $39.72/bbl, but has been above $40 several times. Brent crude added $1/bbl to reach $40.44/bbl. Natural gas prices have been pretty stable as the high demand winter season comes to an end. Since our previous issue the Henry Hub benchmark has lost 6 cents to close at $1.80/MMBtu.
In Other News
- The Energy Information Administration (EIA) projects that natural gas will overtake coal in annual power production for the first time this year
- Peabody Energy (NYSE: BTU) the largest U.S. coal miner, said the industry’s woes may force it to seek bankruptcy protection
- SunEdison’s (NYSE:SUNE) recent troubles continue, as the company warned that its annual report would be delayed to clear up accounting irregularities
- Motiva Enterprises, a joint venture between Royal Dutch Shell (NYSE: RDS-A) and Saudi Aramco is breaking up, giving Saudi Aramco sole possession of the largest U.S. refinery in Port Arthur, Texas
- TransCanada (NYSE: TRP) agreed to buy Columbia Pipeline Group (NYSE: CPGX) for $10.2 billion.