I put together some thoughts on a group of MLPs (Master Limited Partnerships) at the request of a number of subscribers. There are 50 or so U.S. MLPs out there in various parts of the energy business but I limited myself to the upstream (E&P) variety as pipelines and midstream (processing) operations are not my normal ballywick. I’m very comfortable dissecting E&Ps and I took a list of 10 and weeded that down to six I might see investing in for the long term.
Where we are in the cycle. The MLPs have been to hedge funds what money markets are to you and me, a place to deposit cash, only with a much better yield and a fairly predictable and safe one as long as commodity prices are flat or rising. Recently, hedge fund redemptions have pounded the shares. There is actually a MLP index, the Alerian MLP Index, ticker AMZ, which peaked at about 342 in mid July 2008 and hit a low of 151 on October 10 before closing at 220 yesterday. So it's volatile. Look at how the index performed during and following the last few market implosions relative to the S&P500 (the index is blue and the S&P is yellow if you can’t make it out in the chart’s legend):
Still the names are beaten down and yields appear high. One thing I think many investors do when the sector is beaten down is pick the names with the highest yields. I like to say sometimes things are "cheap for a reason." Take QELP, which is not in following tables despite having the highest current yield at 30%. It's got lawsuits, it has financial irregularities, a complex structure to begin with and a CEO who quit when people started asking questions. But that’s the highest yield I could find.
Other metrics are helpful. The industry employs a few metrics in addtion to the ones normally looked at by E&P investors.
- Total Debt / Adjusted EBITDA. You want this one to be low as its essentially a measure of debt in relation to your annual cash flow.
- Adjusted EBITDA / Cash Interest Expense. This one you want to be high as its basically a coverage ratio for your ability to make your interest payments. Everyone in the group below can easily make their interest payments but there are some MLPs in the non-upstream names which come closer to having interest coverage problems.
- Yield…This Is Not Your Father’s Rate of Return. With the stocks pounded down by 1/3 to 1/2 from their peak cycle highs yields are still high. But the next ratio is most important in determining whether or not that distribution (like a dividend but different for tax purposes), and therefore their yield remains in place.
- Distribution Coverage Ratio. This is the ratio of distributable cash flow vs the company’s actual distribution. The higher the ratio the more room the company has if things turn temporarily lower to keep the distribution up.
- LOE. Ok, lease operating expense is standard for E&Ps and I think of high importance when looking at upstream MLPs. The lower the better.
- Reserve Life: Also standard for the E&P, this is a measure of reserves to production (measured in years). The higher this is, the lower your decline rate. Most upstream MLPs focus on cash cow type properties so a reserve life of 20 is not uncommon. Shorter reserve life properties would mean the firm would need not only maintenance capital but acquisition capital shortly just to remain in business. All of the firms in the tables below have long reserve lives.
If I had to pick favorites, I’d go with size. Probably LINE first, which operates a majority of its properties and has a strong management team which impressed at IPAA despite the downtrodden environment, then ATN who is largely Marcellus focused and then EVEP. Even after the modest recovery of the last few days these names are yielding 17%, 13%, 17% respectively with some of the better distribution coverage ratios in the business and better than average operating expenses, especially ATN.