What’s next for MLPs?

April 30, 2013

For my first post back I want to update the last post I did before my hiatus. On Feb 10, I posted on how well the MLP sector did in January, with it being the second best January ever, and that good early year performance usually leads to strong results going forward. Lets see what the MLP sector has been up to since then.

The chart below shows the performance of the AMJ ETF that tracks the MLP sector. What a year so far is all I can say! The MLP index total return for Q1 2013 was 19.7%, far outpacing the SP500. That’s a dam good year of performance in just 3 months. MLP s have advanced a little further in April as expected, given that April is a dividend capture month and historically does well as I’ve discussed before. I hope you enjoyed some these gains – this was a great risk/reward setup at the beginning of the year and at the end of January.

AMJ chart Apr 30 2013

 

The performance in many individual names has been even more impressive. YTD performance, price-only, even with the recent pullbacks: EPD – 25%, NGLS – 27%, TRGP – 28%, PAA – 28%, WMB – 18%, KMI – 12%, KMP – 18%. OKS was about the only real dog among the big MLPs and even that horrible performance was 2% up plus the dividend. Some of the more spec names like LNG and GEL are up almost 50% and 34% respectively. Needless to say that this kind of performance in such a short time doesn’t come around very often. Obviously, the next question is what now?

A couple items to look at to give us an idea of what MLPs could do from here are valuations and historical patterns. First, historically, May is not a good month for MLPs. Its the second worst month, after November. You get the fade of the dividend capture trade, you get equity issuance by many MLPs, and you get part of the general market ‘sell in May’ effect. Second, MLP valuations are not as compelling as the were in November of last year, nor at the beginning of this year. The chart below is the one I like to use for MLP valuation.

MLP historical yield and spread chart apr 30 2013

 

On a yield basis, MLPs are approaching lows in yield since the 2008 crash, but not by much. On a yield spread basis MLPs are not as compelling either and are approaching the average spread. However, historically even these average spreads have led to good returns in the past. Also, compered to other yield based investments MLPs, even at these ‘low’ yields of 5.8% look pretty darn attractive especially against what I think are over valued yield investments like REITs, Utilities, and Junk bonds. Basically. I’d be looking here for a mild pullback in May generating some good setups for the rest of the year. As always, I prefer individual names vs the ETFs and I prefer to have more growth over yield. WMB, ARP, CLMT, and TRGP are some of the more growth oriented names that I like. And I’m always looking for ways to own some of the big boys especially Kinder Morgan and Enterprise Products and good prices.

Hope that helps.

Disclosure: currently long CLMT, ARP, and WMB with some tight stops.


Kinder Morgan reports spectacular Q3 2012 Results

October 26, 2012

Kinder Morgan kicked off MLP earnings season on October 17 with a very strong report. I’ll briefly discuss the report and then discuss valuation and expected future returns for the Kinder Morgan family of companies.

Kinder Morgan’s Q3 2012 earnings were very strong. The full press release is here for KMP, here for KMI, and here for EPB. A few words from the release and from Rich Kinder, the Chairman sums up the results nicely.

Kinder Morgan Energy Partners Increases Quarterly Distribution to $1.26 Per Unit
Distribution 9% Higher Than Third Quarter 2011HOUSTON–(BUSINESS WIRE)–Oct. 17, 2012– Kinder Morgan Energy Partners, L.P. (NYSE: KMP) today increased its quarterly cash distribution per common unit to $1.26 ($5.04 annualized) payable on Nov. 14, 2012, to unitholders of record as of Oct. 31, 2012. This represents a 9 percent increase over the third quarter 2011 cash distribution per unit of $1.16 ($4.64 annualized) and is up from $1.23 per unit ($4.92 annualized) for the second quarter of 2012. KMP has increased the distribution 45 times since current management took over in February 1997.

Chairman and CEO Richard D. Kinder said, “KMP had a strong third quarter with all five of our business segments reporting better results than in the third quarter of 2011. In total, KMP produced $1.14 billion in segment earnings before DD&A and certain items, a 21 percent increase over $0.94 billion for the same period a year ago. Third quarter highlights included contributions from the dropdowns of 100 percent of Tennessee Gas Pipeline (TGP) and 50 percent of El Paso Natural Gas (EPNG), record export coal volumes in our Terminals business, strong oil production at SACROC in our COsegment and increased natural gas demand for electric power generation on the TGP system. Looking ahead, we see significant growth opportunities across all of our business segments, and we remain very excited about the additional prospects that we expect KMP to realize from Kinder Morgan, Inc.’s acquisition of El Paso Corporation, which closed in the second quarter. With our large footprint of assets in North America, KMP is well positioned for future growth.”

KMP reported third quarter distributable cash flow before certain items of $455 million, up 15 percent from $394 million for the comparable period in 2011. Distributable cash flow per unit before certain items was $1.28 compared to $1.19 for the third quarter last year. Third quarter net income before certain items was $574 million compared to $451 million for the same period in 2011. Including certain items, net income was $383 million compared to $216 million for the third quarter last year. Certain items for the third quarter totaled a net loss of $191 million versus a net loss of $235 million for the same period last year.

So, great results a 9% year on year distribution increase, good distribution coverage and a great outlook. What’s not to like? KMI and EPB also has similarly strong results. But, the real question is what can an investor expect going forward? Can we expect a repeat of the past which has been stellar as the table below shows?

Spectacular historical returns, with lower risk, but we are not likely to see those kind of results in the future. Kinder Morgan is much larger both in assets and market cap and valuations are higher today as investors have recognized the appeal of MLPs. In the table below I shows what are reasonable expectation for future returns for the Kinder Morgan family of companies.

In the above table the total return is expected is calculated by adding the current yield to the expected distribution growth. This is what I’ve termed the magic dividend formula and have discussed many times on the blog before. The dividend growth figures are directly from Kinder Morgan management and they have a pretty consistent record of meeting and beating their forecasts. Compare these potential returns from what you can reasonably expect from the SP500. In a rosy scenario, take a 2% current yield plus 6% dividend growth per year, which gives you a potential 8% return. So, the Kinder Morgan numbers look quite attractive especially when you consider that will most likely be less volatile as well as the historical returns show. What could prove to be a spoiler? As always, valuation. I see a lot of articles talking about a dividend  or a yield bubble, etc… Its something to think about.

Below I show the historical valuations for the KMP going back to 1996. I use two metric for dividend investments; current yield compared to history and the current yield spread to the 10 yr treasury as compared to history.

On a yield basis you could say KMP is over valued. On a spread basis KMP is way under valued. This is the case for many dividend investments today due to the very low interest rates we see. Two things; spreads tend to be a better predictor of future results in my experience and the historical yield is distorted by market cap issues. Even just going back 10 years to 2002, KMP had a market cap of $4.5B whereas today it has a market cap of $20B. They are not the same company. I put more emphasis on the spread and thus I think worst case KMP is fairly valued. But as investor you can take advantage of a market idiosyncrasy by investing in KMR shares vs KMP. Its the same economic entity with the only difference being that the dividend is paid out in shares vs cash (and you get a 1099 at the end of the year instead of the pain in the rear K-1s). With KMR you get a 6.6% yield, almost at the historical average, plus that 7% a year growth. Plus, there is the potential upside of the valuation gap closing between KMP and KMR.

In summary, Kinder Morgan continues to perform great and offers excellent potential future returns with relatively low risk. Personally, I prefer to divide my investment in Kinder Morgan  in the general partner, KMI, with it’s higher return potential of almost 17% going forward, plus KMR or EPB for higher current yield. The combination is pretty powerful.

Disclosure: long KMI and KMR


EPD Q2 2012 earnings results – strong and resilient

August 2, 2012

Maybe it’s the contrarian in me but I keep expecting EPD to disappoint. Or maybe I’m hoping they disappoint so I can buy a ton more shares. But alas I was the one disappointed yet again. EPD reported strong Q2 2012 results on Aug 1st. Full release is here. Lets see how strong and resilient their results were.

We are now smack in the middle of MLP earnings season with Kinder Morgan having kicked it off last week. So far the trend in the results has been some weakness in the numbers mainly due to lower oil and NGL prices. In particular, NGL prices were down about 25% from last quarter. This weakness in NGL prices has been mainly felt by the gas processing MLPs. For example, MWE, NGLS, and WPZ all pre-announced weaker Q2 numbers. Even the mighty Kinder Morgan felt some weakness from these lower commodity prices. But then again these results also show the resiliency of the MLP business model. Despite this weak environment all the MLPs I mentioned are sticking to their distribution growth targets for 2012. Their distribution coverage ratios have come down significantly but that’s why they have them in the first place, for times like this. Of course, EPD, along with a few others, has bucked this trend.

Despite NGLs being their largest business, and the weak NGL environment, EPD reported strong numbers and continued strong distribution coverage ratios. The distribution coverage ratio was 1.4x for Q2 2012 after excluding one time gains. From the release:

“Enterprise reported strong results for the second quarter of 2012 with four of our five business segments posting higher gross operating margin than the second quarter of last year,” stated Michael A. Creel, president and CEO of Enterprise. “Gross operating margin for the second quarter of 2012 increased 12 percent from the second quarter of 2011 primarily due to higher volumes of NGLs, natural gas and crude oil handled by our integrated midstream system of assets. The partnership set records with respect to fee-based natural gas processing volumes, natural gas pipeline volumes and NGL fractionation volumes.”

Business is doing well and growth opportunities look great. While EPD is my favorite large cap MLP, results at the other big boys look pretty good too. KMP reported decent numbers despite some weakness. OKS also continues to shine. And I expect PAA which reports this week will also do well. In tougher times the MLPs with diversified business models will tend to perform better. As far as the smaller cap MLPs these tough times may present nice buying opportunities for patient long term investors.

Disclosure: long EPD, KMI


Kinder Morgan Q4’11 earnings – steady & increasing growth

January 22, 2012

Kinder Morgan announced Q4 2011 earnings after market on Jan 18, 2011. Being one of the top 3 MLPs by size, having the most diverse business, and being one of the best managed MLPs I think its illustrative of what is going on in the MLP sector to look at their earnings. This coming week KMP will also hold their annual investor day. The details of KMP’s earnings can be found here.

At a high level, Kinder Morgan had yet another record quarter and again increased distribution to their limited partners. Distributions increased to $1.16 per unit from $1.13 per unit in the same quarter last year, a 3 percent increase. More importantly, for the full year 2011 KMP distributed $4.61 per unit, beating their $4.60 target and an almost 5% increase over the full year 2010 distribution. For this year, 2012, KMP is targeting a distribution of $4.98 per unit, an almost 8% increase over the 2011 annual distribution. This 2012 outlook does not account for the El Paso acquisition which is expected to be immediately accretive to distributions.

I find that I say the same thing every quarter about KMP, ‘steady as she goes’. These guys continue to perform. They make plans, commit to them, and just execute. No other MLP provides such detailed outlooks and forecasts and then just goes out and nails them. This is very comforting to long term investors. Since inception in 1996 they have missed their distribution target only once. Since 1996 investors have enjoyed a 25% CAGR. Their business continues to become more diverse and steady. Here is a summary I did of their business.

As the table shows, KMP has a very well diversified business that is predominantly fee based and not subject to commodity prices. They do have some commodity exposure to oil prices in their CO2 business but they hedge most of that exposure away for the year. So, how about going forward and what can investors expect in terms of returns going forward?

Based on KMP, KMR, and KMI’s closing prices as of Friday, Jan 20th here are the returns investors can expect going forward excluding the effect of the El Paso and including the effect of the El Paso acquisition which is increasing future Kinder Morgan growth. These returns are calculated using the magic dividend formula which states that total return is equal to dividend yield plus dividend growth plus change in valuation. For this table I’m assuming the change in valuation for this year is zero.
I’m using the post EP numbers as a basis for an investment decision due to the very high probability of the acquisition going through. These are solid returns in any environment but even more so in today’s volatile market and in a market where investors are searching for yield. I continue to prefer KMI , with an almost 17% annual forecasted return, over KMR or KMP for the higher total returns but some investors desire higher current yields and thus would prefer those shares.
In summary, Kinder Morgan continues to execute and is the most stable and diverse MLP in the space.
Disclosure: long KMI

MLP valuation at August end

September 1, 2011

It’s been since May that I updated my table on MLP valuation. With the recent volatility in the market and the month of August coming to an end it is a good time to take a look at MLP valuation. Lets jump right in.

As I’ve done before, I updated my top 5 MLP table which also includes the MLP index, AMZ. I like to use both relative and absolute value metrics for any investments and I think the two best are dividend yield and the spread to the 10yr treasury note. Here is the updated table.

MLPs, the AMZ, are trading at a yield of 6.5% and a spread of 4.31%. In relation to their historical trading ranges, MLPs are trading at a lower dividend yield than average but way above their historical spread to treasuries. And here is lies the dilemma when looking at MLP valuation in today’s market. Usually, especially at the extremes, these two metrics move together. In other words, when spreads indicate the MLPs are cheap then the dividend yield is also signaling the same thing. This was definitely the case in the 2008 crises which was the extreme of extremes for MLP history. But this time is different, or so it seems. The question is whether the dividend yield is more correct or the spread to treasuries. Hard to tell, there are many many factors involved. For example, the MLP sector is much bigger, more stable, and more mature than it was 20 years ago. This alone would indicate that the sector would and should trade at a lower dividend yield than in the past. Personally, I lean toward the spread to treasuries as being the better indicator, especially short term, of value which indicates to me the sector is undervalued. However, even better is to focus on individual MLP names which I think is the best way to invest in the sector as I’ve discussed here and here.

As far as the big 5 MLPs are concerned, there is quite a difference in valuations. The lowest valued relative to its history is ETP. It is the only MLP trading at a discount to its historical yield and spread. KMP would be next on the list, trading at only a slight premium to its historical yield. And even better you can increase the yield on KMP by buying the other share class, KMR, at a 14% discount to KMP. At the other end of the spectrum you have EPD and WPZ both of which are trading at good premiums to historical yields. However, in both these companies investors should consider the individual factors that are driving these valuations. For example, EPD is one of the few MLPs without a general partner so its cost of capital is significantly lower than other MLPs. In the WPZ case they have an E&P business that will be spun off later in the year which is impacting valuation. These details matter a lot. Personally, I like KMP and EPD at these levels.

In summary, while MLPs have had quite a ride during the recent market volatility there is good value in the sector. With continues volatility there may be even better buying opportunities coming to a quote screen near you.

 


KMP reports Q2 2011 results

July 21, 2011

Earnings season for the MLP sector officially got underway last night with Kinder Morgan reporting Q2 2011 results. The highlight of the release was a distribution increase to $1.15 per unit or $4.60 annualized. KMP currently yields 6.3% on this dividend. From the release:

HOUSTON, July 20, 2011 – Kinder Morgan Energy Partners, L.P. (NYSE: KMP) today increased its quarterly cash distribution per common unit to $1.15 ($4.60 annualized) payable on Aug. 12, 2011, to unitholders of record as of Aug. 1, 2011. The distribution represents a 6 percent increase over the second quarter 2010 cash distribution per unit of $1.09 ($4.36 annualized).

KMP is on track to beat their financial plan for 2011. As in Q1 they re-iterated on the call that they are ahead of plan and if the current environment continues in the second half they should beat their $4.60 distribution target for this year. The only negatives in the report were a slight decrease in their refined product pipeline volumes due to the weak economy and a non-cash legal reserve charge they took due to a legal rate case in California which they intend to fight. On the positive side the natual gas pipelines segment, the CO2 segment, and the terminals business are all doing very well. There is no better diversified MLP than KMP and they continue to show the strength of their diversification. The table below shows their business breakout as of Q2 2011

The highlight of the earnings announcement was the earnings call that took place after the market closed. It just goes to show how important it is to listen to every earnings call for your stock holdings. On the call there were several important hightlights;

  • Rich Kinder said the current opportunties in the midstream MLP space are the greatest he’s seen in his 30 years in the business. These are important words from the man who basically created the energy MLP sector. This echoes similar comments from other MLPs, like EPD.
  • KMP has taken a preliminary look at 2012 and from a high level they expect to do better than their long term average projections of 5% distribution growth for KMP and 10% for KMI. This bodes well for investors in 2012. Part of this optimism is due to them being able to lock in higher hedge prices for their CO2 and crude oil production. Their 2012 hedges are $18 above their 2011 hedges for example.
  • Current opportunities in the coal export sector, the CO2 sector have the opportunity to drive strong growth. Also, they see more opportunity in the Eagle Ford shale. BHP Billiton’s recent acquisition of Petrohawk (HK) is expected to have a positive impact in drilling in that shale play. They are also very optimistic about the Haynesville shale.

All in all it was another good quarter for KMP. Investors in KMP today get a 6.3% dividend yield with about a 6% growth in distributions this year and it looks like another 6% at least next year. That’s a total return expectation of 12.3% going forward. And its tax deffered. Not bad for the most dividersified, lowest risk MLP in the sector. KMP is the bar which other MLPs should be compared against.

For an even better deal, investors can buy KMR shares which yield 7.1% and have the same growth potential. Also, KMP’s general partner, KMI, yields 4.2% (and also increased its dividend in Q2, to $0.30 per unit) and has a growth potential of 12%, double that of KMP.

Disclosure: long KMP


MLP taxation: the upside of ending the tax break

June 17, 2011

In my last post I described what I consider the worst case scenario for MLPs in the event that their tax favored status ends overnight. Today I want to look at a few of the upsides of such an event. Yes, I do think there are upsides to ending the MLP tax favored status. I can think of four upsides right away; incremental share demand, potential higher valuations, expanded business opportunities, and pricing power. Lets look at each of these possibilities.

While the MLP sector has enjoyed strong and increasing investor demand over the years the tax complications and tax risk has kept many investors away. An ending of the tax break for MLPs would lead to a large incremental demand for shares from several sources. First, many individual investors simply don’t want to deal with the tax complications of K-1 filings or take the risk that the tax advantage goes away thereby hammering share prices. Also, besides a few special share classes, also for tax reasons (UBTI income) MLPs are not suitable investments for retirement accounts. On the institutional side, mutual funds and pension funds, are not large owners of MLPs for similar reasons to those of individual investors. And lastly, no MLPs are included in any of the major indexes like the S&P500. They are not allowed to be. All of these would be the source of incremental share demand for the MLPs, especially the large caps. For example, consider ETP or KMP. ETP has a market cap of $34B and KMP has one of $22B. For the S&P500 index the average market cap is $23B. ETP and KMP would be candidates for the index after the tax change. Choosing an example mid tier S&P500 company, CHK, lets look at the volume of shares traded. CHK has a market cap of $17.8B and its average daily volume is 10.5 million shares. ETP and KMP, with larger market caps, have average daily volumes of 1.3M shares and 0.75M shares respectively. After a tax change, as normal operating companies, EPD and KMP could be added to the index. Needless to say this would lead to more demand for shares in the companies. In short, incremental demand from individuals, institutions, and potentially indexes would be a positive catalyst for MLP post a tax change.

The next potential upside for MLPs post a tax change is higher valuations. The tax complications and risk keep a lid on valuations. The best comparison I can make to MLPs is the utility sector. The company structures, stability of cash flows and dividends, and regulatory environment are very similar. Taking a look at the utility sector, using the utility sector ETF, XLU, we can compare valuations to the MLP sector. The XLU trades at a dividend yield of about 4% and the MLP sector, using AMZ, trades at a yield of about 6%. That’s about a 33% premium for XLU vs AMZ. That’s remarkably similar to the US corporate tax rate of 35%. Coincidence? Maybe but probably not. Post a tax change MLPs would most likely trade at higher valuations than they do today, a big reason of which would be the incremental share demand I described in the first paragraph.

A third potential upside for MLPs from a tax change would be potential new business opportunities. Today, to qualify for MLP status MLPs are limited to businesses that have to do only with energy and energy infrastructure. With an end to the MLP tax status MLPs could potentially pursue other types of infrastructure projects. For example, several MLPs have expressed interest in pursuing water pipelines. And a few have even sought regulatory approval for water pipelines that are related to energy projects.

The last potential upside is the pricing power that MLPs have. Actually, I think this is more of a mitigating factor. One of the core strengths of MLPs is their economic moats. Because of the huge upfront capital investments and lead times required to build energy infrastructure MLPs are able to enter long term contracts, 10-20 years, with their customers. Also, these contracts tend to be predominantly fee based and not subject to commodity price movements. This dynamic leads to strong competitive positions – once a $1B pipeline is built someone is not going to come along and build another $1B pipeline right next to it to compete. In the event of a tax change, where the economic returns of projects go down suddenly, the MLPs would be in a position to renegotiate the contracts with their customers. The impact of the tax change would not just be born by the MLPs but also by their customers, the energy exploration and development companies. I’m not saying the MLPs could make up all the impact but they could certainly offset some of it.

In summary, there are some potential upside catalysts to an MLP tax change. While there is no doubt that in the short term such a change would be painful to existing shareholders it is not all bad. I showed in my previous post, the downside impact is not as bad as it appears on the surface and here I describe a few potential positives from such a change. I don’t think such a tax change is a risk anytime soon, probably not until late 2013 at the earliest, and even then it is only a small risk. But its always good to be prepared and think about the potential consequences of such an event.


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