All Politics Is Local

As a Virginia resident, I was initially bemused by all the national media attention surrounding the run-up to our state’s election this week.

After all, polling on the statewide races, while wrongly suggesting the election was more competitive than it was in actuality, still showed the most likely outcome would be the status quo, at least in terms of which party would control the levers of power.

But that didn’t turn out to be the real story. Instead, it seems like virtually everyone was surprised by what happened in the state legislature.

Going into the election, Republicans had firm control of the Virginia House of Delegates, with 66 seats to 34 for Democrats. And I don’t recall anyone saying that the chamber might be in play.

By the end of Election Day, however, the balance of power had shifted to a roughly even split, though some races were so close that we won’t know how things shake out until recounts are completed.

Ordinarily, a state-level electoral upset might make for good local trivia, at best. But pundits are already looking ahead to whether it might have implications for next year’s Congressional election.

Given the sheer velocity of news in the social-media era, it’s a bit of a stretch to extrapolate what happened in Virginia to what might happen nationally next November. Indeed, who can possibly know what issues might animate the electorate nearly 12 months hence?

But that hasn’t stopped pundits across the political spectrum from such speculation anyway. And members of Congress, many of whom spend much of the year working just across the river from Virginia, are likely paying attention.

Regardless of political leaning, the general consensus seems to be that the GOP-controlled Congress must pass at least one major piece of legislation, so that the party’s incumbents have a significant achievement to tout on the campaign trail next fall.

To this end, the unexpected swing in Virginia likely gives Republican lawmakers an additional sense of urgency.

The Investment Angle

Now, how does all of this tie in with our investments? Well, these political considerations could increase the chance that we finally see sweeping corporate tax reform.

Not only would passage of such a bill help extend the market’s bull run, it could help lift many companies’ bottom lines.

However, even though the House GOP unveiled its tax plan to great fanfare last week, the market is finally waking up to the reality that there are still many hurdles before the finish line is in sight.

This week, for instance, the Senate GOP released its own tax proposal, which moderately diverges from the House plan in a number of areas. The big one, though, is that the Senate is looking to push out the start date of the new 20% corporate tax rate by another year. The market definitely did not like that.

Further, the crowded legislative schedule means that it will be tough for Congress to get tax reform done by the end of the year.

After getting their respective bills through committee, both chambers have to put their plans to a full vote. Then they have to reconcile their differences during conference sessions. That means numerous details could change materially between now and then.

And while passing a tax bill would likely give a number of GOP lawmakers a boost on the campaign trail, other Republican members represent areas where it could be a bust, particularly those in coastal areas with high local taxes and absurdly inflated housing markets.

That’s because Congress is looking to offset tax cuts by finding new sources of revenue, such as by eliminating the deduction for state and local taxes and capping the deduction on mortgage interest.

While the House GOP has enough of a margin that it could allow most members who represent high-cost coastal areas to vote “Nay” without torpedoing the bill, the Senate GOP has a very thin majority. And a handful of Republican senators are already balking at the bill, though there are three Democratic senators who may be open to supporting it.

Despite these complications, what happened in Virginia could still light a fire under lawmakers to actually get tax reform done before it’s too late.

Earnings Updates

After limping through the aftermath of the energy crash, the Energy Transfer empire finally had a respectable quarter. But the market still punished Energy Transfer Equity LP (NYSE: ETE) anyway. Perhaps it’s just muscle memory.

In the wake of its earnings announcement, ETE’s units dropped nearly 7%. Although distributable cash flow declined 3.6% year over year, that was slightly ahead of estimates and still good enough for full distribution coverage, at 1.05 times.

Further, ETE boosted its quarterly payout by 3.5%, to $0.295 per unit, for a forward yield of 6.8%. This was the first distribution increase in two years.

ETP also continued its policy of raising its payout incrementally each quarter, with a 2.7% sequential boost.

As a general partner, ETE derives nearly all of its cash flows from its MLP subsidiaries, particularly Energy Transfer Partners LP (NYSE: ETP). For its part, ETP crushed consensus forecasts for the quarter, with adjusted EBITDA rising 25% year over year, to $1.7 billion, beating estimates by nearly 8%.

Management attributed this performance to higher volumes on its crude oil pipelines and natural gas liquids and refined products infrastructure.

So what accounts for the selloff? Admittedly, I am somewhat puzzled by this action myself.

One possibility is the fact that ETE still subsidizes ETP by waiving a portion of its incentive distribution rights (IDRs). Absent that waiver, ETE would have stronger cash flows, but ETP might not be fully covering its distribution.

With $3 billion of growth projects that will need funding next year, management said it doesn’t expect those waivers to finish rolling off until the end of 2019.

Also, leverage remains a big concern, and the market appears to be looking forward to a simplification transaction—basically a roll-up of ETP into ETE—that would eliminate various drains on cash flows. Management does not expect to undertake such a transaction until late 2019, at the earliest.

Lastly, these days the market is more concerned with distribution coverage than growth in the payout. To this end, other MLPs have recently slowed or temporarily halted distribution growth since they didn’t feel the market had been rewarding them for it.

Given the Energy Transfer empire’s relatively recent struggles and continuing need to reduce leverage, the market may have frowned on distribution growth in this environment.

But investors already knew most of these details prior to this. Perhaps the market expected some news on these fronts, rather than a situation that was more or less status quo. ETE remains a buy.

Shares of TransCanada Corp. (NYSE: TRP, TSX: TRP) have rallied nicely after a brief tumble in late October.

That’s despite the fact that the company reported distributable cash flow fell 29.6% from a year ago, to C$0.88 per share, missing expectations by about 20%.

Part of the decline was driven by sharply higher maintenance spending, particularly on Canadian natural gas pipelines.

The other part was due to an equity issuance that was done last November to help repay a portion of the debt taken out to finance the acquisition of the Columbia Pipeline empire.

However, the market may have been paying more attention to comparable earnings, which were down just 1.3% from a year ago and ahead of estimates.

Also capturing the market’s attention are the improving odds that the Keystone XL pipeline could finally get built.

TransCanada said there’s sufficient demand from shippers to justify the project, but it’s still waiting to get the go-ahead from Nebraska regulators. That decision is expected to come later this month.

Meanwhile, the company continues to quietly execute on its $24 billion near-term capital program, which remains largely on time and on budget.

Management reaffirmed that the company is on track to generate dividend growth of 8% to 10% annually through 2020. TransCanada remains a buy.

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