July 23, 2019

It’s no secret that, for the past five years, investing in energy MLPs has been a losing proposition, aside from collecting dividends while watching your principle erode. The energy boom in the U.S. has involved the building of massive networks of pipelines, storage facilities, transfer stations, and processing facilities, and yet the sector has sorely lagged the broader market by a wide margin.

Even as the price of crude and natural gas have steadily declined over the past couple of years, with the demand for natural gas being particularly strong for domestic and export in the form of LNG, the energy infrastructure sector could hardly find a pulse until just recently. And now, suddenly, out of nowhere and with little if any explanation, the energy MLP space has caught a strong, high-volume bid.

The chart of the Alerian MLP ETF (AMLP, below) shows a well-defined upside breakout this month that has gone fairly unnoticed, save for those of us that write about income investing. The performance of the sector has been like watching paint dry while inflicting cruel and unusual punishment on investors with the typically delayed sending of year-end K-1s that drive up the cost of preparing tax returns.

While there are roughly 50 notable energy MLPs that are publicly traded, only about 15 of them make up the lion’s share of the trading and total market cap for the sector. Within AMLP, the top 10 holdings make up about 75% of the total market value of the shares, and the top five make up about half the holdings.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

So why the fresh breakout now? It’s really hard to say. Some speculate that because some private equity MLPs have chosen to convert to the more institutionally acceptable C-corporation structure, the energy MLPs will do the same over the next couple of years, thereby unleashing higher valuations as investor clamor over the juicy 1099 dividend income in lieu of K-1 related distributions.

Kinder Morgan Inc. (KMI) and ONEOK Inc. (OKE), two former MLPs and now C-corps, set the table a couple years ago for what would now seem to be a movement by several others following the 2017 tax cuts. It wouldn’t surprise me to see more MLPs convert, given how well the stocks trade after the change. Institutional investors and pension funds loathe K-1 investments, even if 5%-8% yields are available.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Energy Infrastructure Offers Deep Value

I suspect that what might be underneath the recent bid for energy MLPs is the prospect of a wave of M&A deals that could bring about much higher stock valuations. Back on May 10 of this year, it was announced the Buckeye Partners LP (BPL) would be bought out for $5.6 billion by IFM Investors. That represented a 20% premium to where the stock was trading at the time.

A couple of things come to mind about this takeover. First, just about every MLP is seeing increased distribution coverage following years of slashing costs and streamlining operations. Some MLPs are approaching distribution coverage of 2x, something unheard of five years ago, when 1x was considered healthy, so distributable cash flows are increasing and with it the prospect of rising quarterly distributions.

Valuations are also dirt cheap, with the biggest names trading at around 10x forward P/E and around 1-2 times book value. As the stock market has rewarded nearly every sector of the market with great fanfare, and while bond and stock dividend yields have plunged, it’s my view that yields on MLPs are about to get a big boost when they report second-quarter results with the announcement of serial distribution increases.

At a time when the hunt for yield in U.S. dollar-denominated assets is about as fierce as can get, this just might be the time when MLPs rise and shine after a long spell in the bear cave.

Navellier & Associates owns PAA and OKE in managed accounts but does not own MPLX, MMP, EPD, ET, BPL, WES, EQM, TGE, ANDX, KMI, or BPL. Bryan Perry does not own any of the above mentioned securities in personal accounts.

About The Author

Bryan Perry

Bryan Perry
SENIOR DIRECTOR

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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