MLPs Entering 2009: High Yields Carry High Levels of Risk 15 comments
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December has been a fairly mild time for the markets, coming off the previous period with extremely high volatility in declining markets. High yield securities also suffered a severe market decline. High yield (junk) bond funds, after getting pummeled, finally rebounded a little off their lows. However, their yields typically remain above 20%. REITs also bounced off their lows but remain at depressed levels offering extremely high yields (many well into double digits). MLPs rebounded, but are operating under a dark cloud.
Early in December, the Alerian MLP Index sank to 160. That held, it bounced up to the 180s and then pulled back again to 166. Today it's 169 where it's having a tougher time attracting buyers.
Two weeks ago, Kinder Morgan (KMR) raised $900M for expansion by selling units (their equity) and debt. Kinder Morgan, the largest MLP, sent a positive signal about MLPs obtaining finance for expansion in today's difficult credit markets.
Then Constellation Energy Partners (CEP) gave early guidance for 2009 which was grim forcing them to slash the distribution to an annualized rate of 52¢ (formerly $2.25). Even now the reduced distribution yields 20%, after a grim announcement CEP can't buy friends. Additional MLPs are selling in single digits, more big cuts are coming at some MLPs. This industry is not accustomed to cuts where increases have become common.
Over the weekend, Barrons published a positive article on Linn Energy (LINE), a small MLP, which jumped more than $2 (from $12) when the stock market opened on Monday. However, even after the gain, its yield is 18%. Meanwhile, Kinder Morgan's stock (KMR) yields 10½% on what must be considered the premier MLP with the lowest level of risk.
An additional problem for MLPs could be the low prices for energy. It shouldn't, they just move oil & gas through their pipelines. But low prices could cause some hiccups that are not readily apparent such as lower production for higher cost energy.
As yield securities, MLPs were assumed to have yields typically 200 basis points above the 10 year Treasury (now 2.1%). In the past, a spread of 400 basis points was considered extremely high, suggesting a very good buying opportunity. The Alerian MLP Index now yields 12½% (highest rate in 13 years for the index), over 1000 basis points above the 10 year Treasury (a spread never before seen). In these times there is a large amount of rough continuing diamonds. Diamonds with tremendous yields will prove rewarding for investors. The problem is separating diamonds from the rest.
Distributions for Q1, along with earnings guidance, will be announced by mid January giving early clues about 2009 results. Today's extraordinary yields for MLPs are discounting a very, very ugly scenario. However, these high yields should help investors weather stormy seas ahead. If marginal MLPS cut distributions, as expected, doubts about the future and especially future distributions will keep MLPs under a cloud for some time. Those high yields are very tempting, but all carry high levels of risk.
Disclosure: no positions
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This article has 15 comments:
I recently bought a basket of American and Canadian Nat Gas Trusts, including LINE at 11.50 and PWE at 10. I'm in the camp that oil and nat gas has bottomed. If Israel boils over into a regional conflict or a series of other geopolitical events occur, oil would go substantially higher in six months or at least to the 75-85 range that OPEC seeks. If oil prices do manage to stay low for an extended period of time, prices will be spring loaded to retest the old highs as soon as demand returns. I really like this group at these levels now that everyone is convinced that oil is going to remain depressed. This is the same group, including GS, that called for 200 dollar a barrel oil right before the collapse.
Several of the dry bulk shippers also look interesting. I dipped into EXM at 4 and PRGN at 2.75, along with some others. The Baltic Dry Index is beaten down to incredibly low levels and credit is slowly returning to the market. Several of the shipping companies have insane dividends and are trading well below book level. China and the USA are going to spend trillions on rebuilding infrastructure which bodes well for the sector.
Are these "investments" risky? They may be. Then again, they may not be any riskier than any other sector in this crazy market. The key is to spread the risk. In retrospect, this may turn out to be the investment opportunity of a lifetime to lock in high yields.
First, as to MLPs, in addition to Linn Energy (which actually is not an MLP but rather is an LLC, with no general partner to collect incentive distribution rights and with all members entitled to vote on company matters), Energy Transfer Partners (ETP) is also worth reviewing. I own a significant amount of ETP, as well as a little Linn (although I will buy more Linn, hopefully at a lower price). ETP pays an annual dividend of $3.58 and the units yield about 10.5% (although it has traded as low as $26 and I was too foolishly nervous to increase my position at that low a price and high a yield). In the third quarter ETP earned enough to increase the distribution as it normally would have, but given the extraordinary economic times it decided to retain the extra cash. As to credit availability it just closed a $600 million note issue (albeit at a 9.6% interest rate) to refinance lines of credit and for general company purposes. Its business seems strong and the dividend appears to be safe.
Some readers have commented about Canadian Energy Trusts, which I have owned, including most of those mentioned. My favorite of all is Crescent Point (CPG.UN on the TSX). For one thing, its management is superb and shareholder-friendly. It has a three year hedging policy which has enabled it to retain its relatively recently enhanced 0.23 cent monthly distribution, giving it a yield of over 12%. It is heavily into the Bakken play of the Williston Basin in Saskatchewan and has very little production in the heavy royalty province of Alberta. Bakken is light and sweet, and it (and CPC.UN) were the subject of favorable articles in a supplement to the December issue of the Oil & Gas Investor magazine. It has large tax pools which may probably enable it to keep up the dividend after the trust becomes a taxable entity. The only problem is that the Canadian dollar has recently sunk vs. the US dollar so the unit holder gets less of the distribution each month. At the current exchange rate the yield for a US holder is reduced from over 12% to just 10% and on a cash flow basis it's about 8.5% after the 15% Canadian tax is withheld.
I also have owned the shipping stocks which have been referred to. I believe that in 2009 the credit markets will open for trade letters of credit and the Brazilian-Chinese steel disputes will be resolved, both of which will be good for dry bulkers, as will the fact that at least 30% of the newbuild orderbook will not be completed. One of the more interesting dry bulkers is the newly public Safe Bulkers (SB), whose dividend yiield is about 40% but seems safe for this year at least. However, it has newbuilds coming on stream in 2010 which will have to be paid for. The safest shipping company stock is Sea Span, a container charterer, which has 35 ships on the water with an average remaining term of 7 years and the closest charter termination 5 years away. These charters are priced very inexpensively (about 25% below the market of six months ago), so when they are up for renewal there won't be calamitous repricing. Its fleet is new and modern. Its 33 ships under construction are all chartered for 11 or 12 years from delivery. All of its charter parties are solid lines. Two are Chinese state controlled, and Maersk and Happag-Lloyd have been around for 100 years each, through the Great Depression and two world wars. While it will need $900 million to pay for its newbuilds in 1010 and 2011, Sea Span has said that it won't issue dilutive equity for two years but will explore other alternatives, such as using as collateral for debt 15 currently unencumbered vessels, joint ventures, sales-leasebacks and financing from company insiders on a basis which preserves the dividend. Moreover, like MLPs and like Linn, most of Sea Span's distributions of $1.90 annualy are returns of capital. The yield at about $8 is approximately 22%.
All of these carry risk, but at least you are being paid to incur it.
I also recently bought shares of CanRoys - HTE and AAV.
Also picked up shares of PRGN.
Looking at some shares of ETP, and WES if the price drops a bit more.
They all have very high dividend payouts, which might get cut, but until they do they are practically paying me to own them.
When the market dips again, as it is likely to do in January, I will try to add to my positions of high yielding energy and shipping stocks.
Kinder Morgan and certainly EPD have very strong cash flows and will make money regardless of product spot prices..they profit strictly on volume......
Have they all been beaten down? Of course..but if you only look in the rear view mirror..like some posters..you'll NEVER make future profits.
For those who have problems in committing to individual stocks (and I can fully appreciate that)..look to some of the very well positioned Closed End Funds...GCS and PWE for instance..These can be found on etfconnect.com..Best wishes and a Happy New Year to all!
On Jan 01 09:37 AM mc2406 wrote:
> Low energy prices are temporary. Any alternative energy effects
> are a long way off. When oil stabilizes in the $50-$90 range the
> solid MLPs will once again go up in price. I'll enjoy the dividends
> in the meantime.
PWE is NOT a closed end fund(CEF), it is NOT a Domestic company. It IS a Canadian Royalty Trust.
Stop feeding newcomers who read your comments, misinformation. The stock market already has enough in the way of Charlatans without your additions. IMO
Here you go Pinelli.
I have a new Pseudonym, I hope you like it.
On Jan 03 01:36 PM NOWHEREMAN wrote:
> Pinelli:
>
> PWE is NOT a closed end fund(CEF), it is NOT a Domestic company.
> It IS a Canadian Royalty Trust.
>
> Stop feeding newcomers who read your comments, misinformation. The
> stock market already has enough in the way of Charlatans without
> your additions. IMO
I wonder why coal stocks have done so well in last week considering probable anti-coal bias of incoming administration and the likes of Browner?
It would be helpful if you were to articulate the risks. To merely say there are risks without any back up ifo is worthless. What is your background? Are you an energy expert?
Give us info. Any idiot can say there are risks.