A Stellar Year for MLPs So Far

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 (IBM), Google (GOOG) & Apple (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).

Year___AMZ____return___AMZX___return

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 (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 (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

Comments

[ironist15:]

I hope your worries are unfounded, Avi. My thinking is: The pipeline MLPs' revenue comes from the carriage of natural gas and petroleum products. While production and delivery may be down at the margins by 2-3%, this will have only a small effect on revenues. In particular, MLPs are NOT exposed to price swings of the underlying commodities. Unless they are over-levered, and cannot renew their financing, it seems likely that MLPs will be able to weather almost any economic downturn. Since natural gas and oil have inelastic demand curves due to their central role in a modern economy, it is difficult to see usage falling enough to damage the MLPs. Since I'm sheltering much of my IRA money in the MLP space, I can only hope my analysis is correct.

Jul 21 10:16 AM

[elliot_mllr:]

I believe that you have understated the increase in the distribution rate of EPD.Its quarterly distribution was increased from $0.515, or an annual rate of $2.15, to $0.545, or an annual rate of $2.18.

Jul 21 11:11 AM

[mark joseph:]

I agree with Ironist15. I cannot see how there is a better safe harbor than pipeline MLP's right now with it's , relative, secure and high returns and capital appreciation, preferential tax status (though I think that is often optimistically misunderstood).

All looks good in MLP land (i own lots... majority of my income portfolio) This all been said, in this market one must never be too cocky or confident of anything. There are real boogey men out there that no one can completely predict what wood pile they are in. remember the notion "safest place to keep your money is a money market"? Then we learned what "breaking the buck" meant.

Jul 27 03:30 PM

[mark joseph:]

One last note regarding Mr. Morris pointing out that MLP's were up 35% this year. Technically that is true, but only after being down over 45% in 2008 (Alerian index). They were one of the most stable sectors from a fundamental business and investment perspective but , ironically, had a worse dive than the overall market. They fell so low that at one point the average yield was around 16% with many solid MLP's returning yields %'s in the mid 20's. That makes this years growth (2009) far more justifiable and less concerning. It would be stranger and for more unexplainable if they did not rally in 2009 considering the irrational MLP crash in 2008.

I think it is far simpler to look at the sector yield to see if they MLP's are over priced. Right now they sit right in their normal range (around 8%) which is high by any other sector measure.

Jul 27 04:24 PM