A Show Of Strength

Over the past four weeks, crude went from $47/bbl to $53 and back to $50, while the SPDR S&P Oil & Gas Exploration and Production (XOP), effectively the shale drilling ETF, has shed 6%.

The broader market has continued to drift; the S&P 500 is down a bit more than 2% from the record high set on March 1.

Energy stocks’ recent weakness may have been compounded by the liquidation of positions by a hedge fund. These are the sorts of theories one sees when the buyers simply aren’t there.

But at least it’s not as if most sellers are clamoring to get out of Dodge, as reflected in the mildness of the entire pullback. The Alerian MLP Index (AMZ) is down 6% since its peak on Jan. 26 and still up 0.6% year-to-date, or 2% including distributions.

One keen MLP industry observer, Hinds Howard of the highly recommended MLPguy.com weekly blog, compares the recent stretch to getting stuck in traffic, his point being that we’re still likely to reach our expected destination of stronger domestic energy production volumes and healthier midstream profit margins.  

And while we sit and wait I keep seeing quiet strength in numerous portfolio picks that have given up little if any ground.

These are the likely leaders of the next rally, so let’s take a look at who’s hanging in there better than most. This is not a new Best Buys list, though it’s nice to see several Best Buys represented.

Energy Transfer Equity (NYSE: ETE): -4.5% YTD

The #1 Best Buy started 2017 near the top of its narrow current trading range, and is in fact up 4% from the Jan. 19 low. In other words, it hasn’t done much of late, which is a victory of sorts in this energy market. Investors are waiting for the imminent completion of the merger between ETE’s two main MLP affiliates. More to the point, limited partners in those MLPs are insisting on a punitively high yield of nearly 9% that will have to come down if the merged affiliate is to remain a meaningful source of equity financing for new projects. I expect them to come down over time given the quality and the upside of Energy Transfer’s Assets. But, if not, ETE can avail itself of the solutions adopted by rivals in similar straits over the past two years. It can choose to buy out its MLPs or perhaps sell them its incentive distribution rights in exchange for an expanded equity stake. Either way, the Energy Transfer complex as a whole continues to trade at a discount to less capable midstream empires and I expect more outperform once the organizational issues are resolved.

Williams (NYSE: WMB): -3.6% YTD

Here again the year-to-date numbers don’t tell the whole story: shares of the #7 Best Buy are up 5% since Jan. 10, the day they were down 11% in response to the deal eliminating WMB’s incentive distribution rights in exchange for additional Williams Partners (NYSE: WPZ) equity. And as I’ve argued ever since complaints that Williams didn’t get the best price miss the point: which is that getting the deal done on terms supportive of WPZ was much more important than squeezing every possible advantage from the affiliated MLP. Williams is now a much simpler story, and the attractions of its demand-driven Transco pipeline expansions will be that much more obvious once it completes the sale of its Gulf Coast olefins plant. I still expect Enterprise Products Partners (EPD) to come knocking at some point; last year EPD didn’t deny its interest in a merger with Williams if the price is right.

UGI (NYSE: UGI): +7% YTD      

The natural gas utility continues to draw additional strength from its unregulated propane distribution businesses in the U.S. (as the general partner of the AmeriGas Partners (NYSE: APU) MLP) and Europe (where is has rationalized several franchises primarily in the better-performing northern and eastern parts of the continent in recent years.) The utility gas distribution business has become much more attractive to electric utilities starved of growth, as noted in a recent post recommending three other plays on this theme. Those picks have also held up well over the last month. 

Enviva Partners (NYSE: EVA): +9.7% YTD

The leading supplier of wood pellets increasingly replacing coal in European power plants is near new highs ahead of quarterly results due May 10. It delivered a 1.28x coverage ratio for all of 2016 and raised its most recent payout 16% year-over-year and forecast distribution growth of 12% for 2017. It still yields a healthy annualized 7.3% based on the most recent payout. Like the others picks highlighted here, Enviva has shown no sign of selling pressure amid recent market weakness, and that’s usually a good omen for when the bulls perk up. I’m raising the recently surpassed buy limit to $33.

Incidentally, Enviva remains one of my best recent calls with a 46% total return in 13 months, while UGI is up 49% since it was added to the portfolio in early 2015. Despite last year’s beating and the broad energy bust, EQT Midstream Partners (NYSE: EQM) has returned 90% in less than four years. TerraForm Power Inc (NASDAQ: TERP) was added early last year and has returned 54%. If you’ve had success with our recommendations, we’d love to hear the details. You can share them by participating in this very short and easy survey.

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