A Stellar Year for MLPs So Far

by: Avi Morris

While the Dow is struggling to get back to its 2009 starting value, this has been exceptional period for high tech companies, such as IBM (NYSE:IBM), Google (NASDAQ:GOOG) & Apple (NASDAQ:AAPL), and MLPs. The Alerian MLP Index is up 35% YTD. The MLP index including reinvested income is up more than 40% YTD. These exceptional gains took only 7 months and compare favorably with the best yearly returns for each MLP index (AMZ is the index, AMZX includes reinvested income).


2000 _131.08 __32.88% _191.75 __45.71%
2001 _176.27__ 34.47% _275.61 __43.73%
2003 _214.26__ 35.06% _384.99 __44.54%

Source: Alerian Capital Management

Yields are very important for this sector. Traditionally their yields have been 200 basis points above the 10 year Treasury bond yield. At the recent stock market bottom, that spread shot up to over 1200 basis points. With this year's rally, the spread has narrowed to a more modest 500 basis. Yield spreads for REIT and junk bond yields show similar trends.

Where do MLPs go from here? MLPs have not been adversely affected by the credit crisis in a major way. Only 3 were forced to slash their distributions to conserve money for quicker loan repayment. Other MLPs have continued paying distributions while extending loans, obtaining additional debt financing and selling more equity units. Kinder Morgan (NYSE:KMP), the largest MLP, has arranged more financing for its expansion and has already raised 75% of its $1 billion equity goal for 2009. In Q1, they raised the distribution to a $4.20 annual rate and intend to maintain that record rate for all of 2009. Enterprise Products Partners (NYSE:EPD) expects to become the largest MLP after acquiring TEPPCO Partners (TPP). It has an enviable 5 year track record of quarter over quarter increases for its distribution, the annual distribution rate for Q3 was just hiked to $2.00.

In 2009 junk bond funds have generally been able to maintain their dividend rates, at least so far. Their rebound this year is similar to the MLP recovery. But junk bonds are expected to be facing significantly higher default rates in the coming months. Some of the biggest REITs have reduced dividends as they are already feeling adverse effects from the recession. Meanwhile, most MLPs have maintained (or increased) distributions which are paid from distributable cash flow. They still don't report distributable cash flow per unit which makes me worry about justification for paying those distributions. Q2 reports will be reported in the next couple of weeks. They will probably continue showing results as in Q1, numbers (revenues and earnings) suggesting that their businesses are sluggish while distributions are continued (if not increased). Substantial out performance for most MLPs during the greatest recession in over 75 years continues to worry me.

Disclosure: no positions