From this week’s Barron’s magazine…
In the never-ending search for yield in a zero-rate environment, investors are increasingly turning to master limited partnerships. Barron’s interviewed Kyri Loupis of Goldman Sachs and Chris Eades of ClearBridge Investments to explain the opportunities and risks in this area of the market. They picked their favorite MLPs and advised caution on those involved in refining, drilling, and fertilizers.
The New MLP Landscape
By Dimitra DeFotis
There are approximately 100 master limited partnerships (MLPs) available to retail investors. They are popular in today’s low interest rate environment due to their unique tax structure and because they pay out most of their cash flow to shareholders.
The most common MLPs transport and store crude oil and natural gas, and there been an explosion in drilling in the U.S. About 30 new MLPs have been created in the past two years.
After beating the S&P for twelve years running, MLPs stumbled a bit in 2012. The Alerian MLP Index returned less than five percent, versus 16% for the S&P. The MLP landscape is changing, these experts said. There are still plenty of opportunities to find steady high yields in this space, but investors have to be picky.
The key ingredient in picking MLPs is steady or increasing cash payouts to shareholders. The new breed of MLPs are riskier than the traditional ones for two reasons. First, the new issues are being used to finance the massive build-out of new energy infrastructure projects, such as processing plants and storage facilities. There is a possibility that this could result in an overcapacity that would hurt profit margins in the future.
The second risk is in the nature of the way these securities pay distributions to shareholders. The new model is called “variable distribution policy” which means that the payments are not fixed and stable, like they are for the older models. The payouts will go up and down with the underlying cash-flow streams. This can result in large swings in the market price of these new MLPs.
The experts agree that the best way to invest in this space is to look for the issues that have consistent and above-average distribution growth. Here are the picks from Eades and Loupis:
Oiltanking Partners (OILT)
Western Gas (WES)
Targa Resources (NGLS)
Oneok Partners (OKS)
MarkWest Energy Partners (MWE)
Genesis Energy (GEL)
Tesoro Logistics (TLLP)
“We like MLPs a lot, but we prefer pipelines rather than those that are heavily dependent on energy prices,” says Krishna Memani from Oppenheimer Funds. “If an MLP is entirely resource-based, the variability of payouts is substantial.”
J. Michael Bollinger of Morgan Stanley sticks exclusively with traditional MLPs, seeking stable income and distribution growth over time. The new breed of MLPs tend to be invested in assets that naturally decline in value over time. “Investors have no idea what the discount should be for these new offerings relative to traditional MLPs.”
Greg Reid of Salient Partners says that the new MLPs tend to be dominated by institutional investors. “We view them as 3 to 12 month holdings, not 1 to 5 years, and sometimes you’ve got to move out of them before the cycle turns against you. They’re not buy-and-hold stocks.”