Master limited partnerships are experiencing turmoil, as low energy prices and related issues hurt valuations. But the business model itself – which churns out distributions to investors – is sound, according to Cushing Asset Management.
“The model is not broken, it’s just more challenged right now,” said Jerry Swank, a founder and chief investment officer of Cushing Asset Management, a unit of Swank Capital focused on energy investing, during a conference call.
The ability to export crude oil – which appears to be gaining traction on Capitol Hill – “would be a game changer for the space,” said Kevin Gallagher, portfolio manager and senior research analyst with Cushing, during Tuesday’s webinar. “There are bright spots in the industry,” despite the fact that we are in the downward curve of a cycle.
In the third quarter of 2015, earnings were “pretty solid,” Gallagher says. The industry’s tracking index, the Alerian MLP Index (AMZ) had distribution growth of nearly 9% year over year. General partner MLPs (or GPs) had distribution growth of about 16%.
However, the sector – as measured by price returns – was down 45% as of Dec. 11.
MLPs generally pay dividends from their cash flows, not from debt and equity, which is used to fund growth, Swank points out. “They are making good money when the cost of capital is low for new projects.”
Plains All American Pipeline (PAA), for instance, isn’t planning distribution growth for 2016, Swank explains. “But they have new projects set for 2017 and could [boost distributions] as that comes online,” he said.
On Dec. 8, pipeline operator Kinder Morgan (KMI) said it would cut its distribution by 75%. A few days later, though, it said it planned to fund dividend growth of 6% to 10% in 2016.
“In the next two weeks, we could see some [negative] factors go away,” Gallagher said. “Evaluations are extremely attractive right now, and we could see a nice rally. Midstream MLPs are not going away … things seem grim, but we may have an opening in exports.”
By the Numbers
Large-cap MLPs are currently yielding between 10% and 15%, Cushing analysts say, indicating the market’s expectation for distribution cuts, “which we simply do not see playing out,” according to presentation slides from the group.
Of course, it’s tough to call a bottom. But even with further volatility expected, the group sees the current discount of MLPs relative to dividend discount model-based intrinsic values, historical averages multiples and other yield alternatives as a signal of “an excellent buying opportunity.”
Midstream MLPs have an average current yield of 9.8%, for instance, vs. 8.8% for high-yield bonds and 2.2% for the 10-year Treasury.
A sustained rally for MLPs, of course, depends on a shift in crude oil prices. If the average price were to stabilize near $60 per barrel, that “would heal a lot of wounds in the energy sector,” the group said in its presentation.
“Many midstream MLPs continue to have little to no direct exposure to crude oil prices,” Cushing said. “However, negative energy sentiment is damaging their ability to access reasonably priced capital, creating the ‘negative feedback loop.’”
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