Second Blood?

With Congressional Republicans haggling over the last few details in the tax bill, it looks like MLP investors are getting most of what we wanted.

A top marginal rate on income of 37% coupled with a 20% deduction for pass-through income roughly preserves the status quo relative to the corporate tax rate, which is being cut to 21%.

However, one area of concern is the limit on interest deduction. This could weigh on capital-intensive midstream companies with significant debt. Lobbyists are working hard to carve out an exemption for the industry.

Meanwhile, as expected the Fed hiked short-term rates by another quarter point, to 1.5%.  The central bank has done such a good job of telegraphing its intentions that the market mostly yawned in response.

I’ve reviewed the so-called Dot Plot, which aggregates central bank policymakers’ predictions. The Fed still expects to raise rates three times next year.

And its forecast for the longer-term rate remains 2.75%. That’s the level which the central bank believes is neutral for the overall economy, where inflation is running neither too hot, nor too cold.

The one change from the last round of predictions is that the forecast for 2020 inched up to 3.062% from 2.875%.

As for traders, there’s still a disconnect between their expectations and those of the central bank. Action on the federal funds futures market still implies just two rate hikes next year.

With energy prices up this week, many of our MLPs and other names with energy exposure rallied strongly, though Black Stone Minerals LP (NYSE: BSM) inexplicably sold off.

And Sanchez Midstream Partners LP (NYSE: SNMP) continues to remain challenged.

We’re expecting cash flows to jump sharply next year, though we wonder if it’s prudent for the MLP to continue boosting its distribution when its unit price is so depressed. Of course, a pause in distribution growth would likely only arouse suspicions that something bad is about to happen.

Still, we’re going to need to see a recovery in the unit price. Most MLPs use their equity to help finance new growth. But with a forward yield of 17.2%, Sanchez’s cost of capital is way too high.

The market has been punishing MLPs this year, even though energy prices are higher. If the new year lifts sentiment, then that could go a long way toward repairing the situation.

Speaking of punishment, one of your fellow subscribers recently inquired about the possibility of adding Macquarie Infrastructure Partners LP (NYSE: MIC) to the Income Millionaire Portfolio.

Currently, I recommend the stock in the Income Portfolio of Personal Finance, our publisher’s flagship newsletter.

But I’ve taken a lot of heat for that recommendation there, which admittedly makes me hesitant to add it here. Well, that and the fact that I don’t want too much overlap between the services.

We added MIC to the PF Income Portfolio after it had already sold off. But it has since declined even further. Nevertheless, I’ve been comfortable holding it because I believe it’s getting lumped in (unfairly) with midstream MLPs even though its assets are far more diversified.

MIC is essentially the publicly traded private-equity portfolio of Macquarie Infrastructure and Real Assets (MIRA), an asset manager backed by Australian banking giant Macquarie Group Ltd.

Management has invested in U.S. businesses that operate in four areas, including storage for oil and other liquid fuels (42.8% of full-year 2016 profits), aviation services (30.7%), natural gas and propane distribution (20.3%), and contracted gas-fired and renewable power generation (6.2%).

As a yield-oriented investment vehicle, MIC is focused on businesses with growing and predictable cash flows to sustain a rising payout. To this end, the firm has grown its distribution 12.8% annually over the past three years, for a forward yield of 8.8%.

So MIC definitely qualifies for Income Millionaire. And adding it now would mean we get to pick it up at a depressed price, while locking in a high yield.

The one concern in the back of my mind is that it has been previously targeted by everyone’s “favorite” short-side analyst, Kevin Kaiser. You know, the guy who taunted Energy Transfer CEO Kelcy Warren like a schoolyard bully.

Earlier this year, the Hedgeye analyst published a skeptical report about Macquarie that helped knock it down. PF added it to the Income Portfolio about six weeks later.

While most of the points Kaiser raised are easy to dismiss for anyone who’s familiar with MIC and how it operates, I can’t help wondering if he’ll come back for second blood.

Still, we can’t base our investment decisions on whether a short-side analyst with a mixed record will continue to attack. So I am considering adding MIC to the portfolio. Let me know what you think.

Stock Talk



thanks for the update on the tax legislation
appreciate if you can keep us updated on the limit for interest deduction in new tax bill as it effects MLPs

Ari Charney

Ari Charney


A bit of good news on this front, thought it’s somewhat of a split decision. The House proposal limited the interest deduction at 30% of EBITDA, while the Senate proposal capped it at 30% of EBIT. The latter is obviously a far more restrictive standard, especially for capital-intensive industries like pipeline companies.

It looks like the final bill will use EBITDA as the metric for the first four years, then EBIT after that.

I reviewed the MLP universe by comparing trailing 12-month EBITDA to trailing 12-month interest expense. Most MLPs fall below the 30% threshold. The sector averages around 28%.

But EBIT would obviously be a different story.

In digging through the text of the tax bill, it looks like there is an exception granted for gas transmission pipelines. But that’s the only midstream infrastructure specifically referenced.

If a carve-out for MLPs doesn’t happen with this bill, then it’s possible it could be subsequently added via a tax extenders bill. That’s not a great solution–extenders are technically temporary, though many get renewed year after year.

Best regards,

Add New Comments

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