MLPs Getting Through Earnings Season

 |  Includes: BBEPQ, EROC, KMP, SPP
by: Avi Morris

MLPs have been on a winning streak all year. The Alerian MLP Index started at 169 and shot up to 212 (26%) on May 1 in a year when many don't know the meaning of word "up." They got through Q1 in good shape, only one MLP, Constellation Energy (CEP), had a (sharp) reduction in its distribution.

Q2 results are largely in with just two distribution cuts. BreitBurn Energy Partners (BBEP) eliminated the distribution and Eagle Rock Energy Partners (NASDAQ:EROC) cut theirs to a nominal amount. Reductions were made to allow the partnerships to concentrate on paying down loans. BreitBurn has already rebounded a point from its low two weeks ago. Eagle Rock just announced their cut (not enough time for a rebound).

But that's the bad news for an industry operating in the worst economy since the depression. Other MLPs have maintained distributions and a few have had quarter over quarter distribution increases. But they may be feeling the effects of a slow economy more than they have been letting on.

Kinder Morgan (NYSE:KMP), the largest MLP, started the year by raising the distribution to a record $4.20 (annualized). They also gave guidance that the distribution for 2009 would be $4.20 (i.e. no quarter over quarter increases). Kinder Morgan just reported lower earnings in Q1, something the industry takes in stride. Lower earnings do not correlate with lower distributions because payments are made from cash flow.

A big problem with MLPs is that their profitability is difficult to understand, they need to do more to explain where money comes from to pay distributions. MLPs pay distributions from what they call distributable cash flow, but do not give a per unit amount as is the case with REITs. REITs pay dividends from defined cash flow, funds from operations (FFO). They give FFO per share numbers and show the trend along with EPS data. Without a per unit measure, it is difficult to properly assess how well MLPs are covering their distribution payments and when it might be necessary to reduce the amount. This is an industry not known for distribution cuts, until now. The 3 reductions this year were severe, 80-100%.

MLPs have outperformed stocks in 2009 by a wide margin because industry fundamentals (long term assets supplying energy products for which there is excellent demand) are strong. They generally own pipelines which are expected to last 50 years (if not longer) financed with long term debt and equity.

Because of the problems in the financial industry, they have all been arranging for and extending financing to carry them through these difficult times. But I keep worrying they are getting pinched harder by recessionary forces that we do not understand. Their units may be on a rocky road after an excellent start in 2009. At least high yields (9½% for the index) will limit any damage from falling unit prices.