MLPs Have Had a Great Year - So Far

by: Avi Morris

The bull market passed a milestone on Friday as the Dow Jones Industrials became the last major index to break into the black for 2009. However the S&P 500 is only marginally higher, up 4%.

MLPs continue to have one of the best gains this year. The Alerian MLP Index (AMZ) has already had the equivalent of two very good years, but this was done in less than 6 months. The MLP Index with reinvested income (AMZX) has done even better. Their long term outlook remains bright. Each index started at 100 on 12/31/1995. The second index shows the success of MLP investment over the years largely comes from reinvested income.

Dec 31, 2008__176
Jun 12, 2009__230

Dec 31, 2008__428
Jun 12, 2009__583

The MLP index has recovered back to its value at the start of October and is only down modestly from levels prior to the collapse of Lehman in September. Rising prices reduced the yield for MLPs. The index yielded 12.1% at the start of this year, more than 900 basis points above the Treasury rate. That yield has fallen to 8.7%, only 490 basis points above the Treasury bond yield. Even though the spread is substantially above the traditional 200 basis point difference, the reduction in yield spreads may be too much, too fast because the economy has not recovered from the recession

Treasuries sold off badly this year (causing the yields to shoot up) following 2008, one of their best years. Some of that money has been used to buy high risk securities (MLPs, REITs, junk bond funds, etc.) to obtain substantially greater income. But the narrowing spread (risk premium) over the Treasury bond yield may not properly reflect risks in the economy.

Excellent track records of MLPs with strong fundamentals seem to be working in their favor in 2009. They have access to capital for financing additions to pipelines and extending loans. Selling more units to boost equity has not been a problem. Just last week more units were sold, including by MLP leader Kinder Morgan (NYSE:KMP). Unit sales boost capital but also dilute interests of existing unit holders.

The lack of suffering at MLPs during a time when most businesses are making big cutbacks is difficult to understand, especially when they increase distributions. Money for distributions comes from distributable cash flow, but they do not report this key measure on a per unit basis. It appears as though distribution increases might be tougher to justify in today's recessionary environment if they were measured against distributable cash flow per unit.

As a reminder, I still like the energy business. MLPs have excellent track records which are expected to continue. But the immediate road in front of them may be rocky.

Disclosure: no positions