This is one of an ongoing series of articles examining dividend income equity investments using YDP chart analysis for screening.
Introduction: (readers already familiar with my YDP charts can skip this section and go directly to the MMLP Analysis)
A while back, as part of an article I wrote examining some mREITs, I developed a simple comparison chart of Yield vs. Dividend vs. Price (YDP chart) that both myself and my readers found useful. These charts offer a clear visual tool to help examine when share price was getting ahead or falling behind the particular investment's traditional market valuation.
Reasons For Using This Screen:
Because both Royalty Trusts and mREITs are generally dividend income investments, I decided to apply this screen to some MLPs since they fit in that same category. A word of caution is advisable before we proceed further. This is only a screening tool. It must be combined with more in depth evaluation of a full spectrum of traditional fundamental metrics and technical chart trends in order to make a fully informed investment decision.
Today, I extend the YDP chart screen to an MLP since they share membership in the family of dividend income equity investments. However, there are some fundamental differences beyond their tax treatment that differentiate MLPs from REITs and Royalty Trusts. These are discussed in the body of the analysis of MMLP below.
How The Screen Works:
Yield = Distribution/share price ( Y = D/P). This is a fundamental inverse mathematical relationship. For a fixed distribution, yield will vary inversely to share price change.
For example, a reliable steady dividend distribution of 3% from a mature company in a mature industry (a cash cow) will generally see its share price steady along with the steady dividend. So long as the distribution remains constant, any change in the effective yield is solely a reflection in changes in share price. Simply put, a $10 stock with a $0.30 annual distribution is a 3% yield. If the share price moves to $15 but distribution remains at $0.30, then the yield is reduced to 2%.
So long as the distribution remains constant, any change in share price directly reflects a change in the marketplace's premium it offers for this distribution. Changes in the marketplace premium (discount) may be due to factors such as;
- Prevailing market interests rates.
- Perceived sector/industry risk to the distribution.
- Perceived internal company risk for maintaining the distribution.
- Change in demand whereby the number of investors competing for the rate drives share price up/down.
- Temporary unbalance of price versus distribution.
This last factor in the above list is particularly important to us. Shares temporarily out of their tradition balance with yield are signals to buy or sell for gains beyond the income stream from their distribution (or to use covered options to increase income while continuing to hold shares for the dividend income). It is also important to discover when changes are not due to a temporary imbalance but instead signal one of the other factors entering into play. Furthermore, when a large number of companies in the same category all show YDP trends departing in the same direction from their historic trend, it helps identify an external factor driving the change rather than something internal to a given company. The YDP chart can be a very useful tool in helping to discern many subtle factors responsible for changes in yield independent of the pure mathematical relationship.
Because all five of the listed factors, and more, influence departures from the pure inverse Y=D/P relationship, it can be difficult to filter the signal from the noise. Yet this is critical both for understanding what has driven the share price historically, and thus, will likely do so in the future and for a context in evaluating the current price of shares relative to the marketplace fair value historically. The YDP screen charts presented here help to make this a more visual task and thus more intuitive.
The comparison of historic and current trends in share price, dividend distribution and effective yield provides a strong visual graphic understanding of how the market values a given income producing investment over time. This view of historic data begins with the assumption that for a constant distribution, share price and yield rate have an inverse relationship (the Y=D/P factor).
Using this initial assumption and fundamental mathematical relationship, dividend income investments are evaluated to see when the price to distribution ratio is getting ahead or behind the historic market valuation of the fundamental cash distribution.
Martin Midstream Partners (MMLP) Analysis:
Martin Midstream Partners engages in the gathering, transport, storage, and sales of petroleum and related products in the United States Gulf Coast region. It is structured as an MLP for tax efficiency as dividend income equity investment.
As such, MMLP is in the equity family that can be screened for value and anomalies departing from its historic yield-based valuations using YDP chart analysis. Such anomalies may be created by internal or external factors and signal the need to identify their cause using further research beyond the screening tool to best understand the underlying cause of the departures from historic trends and the mathematic Y = D/P (where Y is Yield, D is Dividend Distribution, and P is share price).
MMLP data by YCharts
The company's YDP chart is virtually a text book classic but not quite so. Even for such a classic chart, there is a lot of analysis available. An important subtle hidden anomaly is present in the chart. Share price is almost exactly a mirror image of yield rate and correlates strongly with the gradual rise in share price that accompanies growth of the dividend distribution. Share price has risen 25% from $27.99 in early 2004 to its present $34.98. Concurrently, dividend distribution has grown 88.6% from $2.10 in 2004 to the present $3.96. A constant yield of 7.5% seen at the opening of this period in 2004 would require a $52.80 current share price, $17.82 (50.9%) above current share price. Factoring in an advance in yield rate from 7.5% to 8.76% effective yield on distribution, a 16.8% increase in effective yield, implies a share price of $45.20 to achieve that mathematical model yield after allowing for the marketplace adjustments setting an 8.76% yield as representing fair value on the distribution. This is still $10.22 (29.2%) above current share price.
Restating the calculations of the preceding paragraph in plain English yields the following statement. Starting from the premise that the marketplace has adjusted its definition of fair value from 7.5% effective yield on MMLP distributions to 8.76%, share price for the current $3.96 distribution should have grown to a current $45.20. This is $10.22 over the actual current market price. Why is this large deviation from expected price not apparent on the chart at first glance? The answer lays in the major downward price deflection during the 2008 financial crisis. Share price appears to have recovered by 2011 to its former pre-crisis levels. This is a false visual impression however. Dividend distribution growth not only did not falter along with share price, it continued to rise throughout the 30 month crisis recovery period. Share prices have never fully recovered to pre-crisis levels after accounting for this continuous advance of distribution against falling share price.
The fact that this change is gradual and so uniform as to be virtually undetectable in the curves possibly indicates the factors driving it are external to MMLP and perhaps even external to the industry, being more of a macro economic factor.
Further research by comparing multiple peer group patterns within the industry and across the entire dividend income group family would shed light on what factors are most responsible for this softening of premium value to the distribution stream. This is needed to determine how far undervalued (if any) the shares currently are. That is beyond the scope of this immediate article. Future articles in this series will add to the database of peer industry YDP patterns and Dividend Income Family YDP members in general and thus provide the raw material for anyone interested in pursuing this by following the development of YDP database and analysis. If I receive enough direct requests, I will undertake a separate article on such a peer group pattern charting and analysis as a dedicated project.
Up until this point, I have been using the stated assumption that the markets set share price to fair value by bidding up or down share price to create an effective yield rate, risk adjusted, on the distribution stream competitive against other choices for income streams.
The legal requirement for REITs and Royalty Trusts is to distribute a minimum of over 90% (95% pre-2001) of their taxable income. Thus, for REITs and Royalty Trusts, management can not control payout ratio by much. The marketplace sets a competitive yield rate for their distributions against competing equity income stream yields by bidding the share price up or down until it is in balance with prevailing risk adjusted yield rates. This is much like the way markets set value for bonds. Share price is effectively the single variable balancing the Y = D/P equation for these entities.
This assumption is not true for MLPs. Unlike REITs and Royalty Trusts, MLPs do not have any minimum distributions rates required by law. Thus, management is at liberty to adjust distribution size and the payout ratio at its discretion (subject of course to any covenants in loan agreements it is encumbered by).
If MLP share prices fail to reward a given distribution and yield rates rise above competitive market rates then management is free to adjust distribution rate to keep it in-line with competitive rates. Therefore, share price is not the lone variable when yield rate is fixed by market competition. Instead, MLPs have two variables, distribution size and share price to balance in reaching competitive market yield rates. Fair value is subject to longer period and greater magnitude distortion from a lag in response between adjustments of these 2 variables as opposed to the essentially single variable share price of REITs and Royalty Trusts.
This makes MLP value analysis fundamentally different than that for REITs and Royalty Trusts. I began by using the share price = fair value assumption for MLPs. However, in the course of analysis, a 30% discrepancy between share price and modeled value has shown up. Therefore, it is now timely and reasonable to test value by other metrics to account for the 29.2% ($10.22) mismatch given from the initial working assumption.
Summary and Conclusions:
- Share price has grown 25% since 2004
- Dividend Yield has increased 88.6% for the same period
- Yield has advanced 16.8% from 7.5% in 2004 to 8.76% currently
- The YDP chart analysis has identified an anomaly of 29.2% ($10.22) deficit in current share price compared against the expected Y = D/P model exists.
- Further analysis of value is required by either other fundamental valuation methods or by comparing YDP behavior of MMLP against a YDP chart set of a broad range of MLPs as a standard to measure MMLP trend departures from.
- MLP YDP analysis is fundamentally different from that of REITs and Royalty Trusts due to the 2 variable nature of MLPs vs. the single variable nature of the former.
- The large size of the pricing anomaly MMLP and its development concurrent with the post-2008 crisis period make it likely an opportunity to either long or short the shares exists. While YDP screening has identified this imbalance, only further research will determine which strategy is best to profit from it.
Disclaimer: I am not a licensed securities dealer or advisor. The views here are solely my own and should not be considered or used for investment advice. As always, individuals should determine the suitability for their own situation and perform their own due diligence before making any investment.