MLPs Soar to New Highs in 2009

This year the stock market started with a continuation of a down market followed by one of its sharpest rallies beginning in early March. But the recovery has not been evenly spread as with all prior recoveries. Tech stocks have had a very strong rally. Nasdaq has been leading the way, already up 25% YTD. Such a gain for a full year would be considered outstanding. Investor appetite for risk (tech and high yield securities) has been very strong in the last few months.

The Alerian MLP Index (AMZ) is up 42% YTD and the index with reinvested income (AMZX) is up 47% YTD while the Dow is up only 4%. Junk bonds have also had a very strong rally with many of the funds up 50%+ YTD from depressed levels at the start of 2009 when yields of 20-25% were common.

The YTD advance already represents the largest yearly gain in the history of the MLP Index.

Source: Alerian Capital

MLPs have had success raising additional capital, debt and equity, during the credit crisis. For example, Kinder Morgan (KMP), the largest MLP, has raised 75% of their $1 billion equity target for 2009. Others have not have problems raising additional capital to finance investments (basically pipelines). And most have increased distributions or at least kept them flat in 2009. Only a few have had distribution cuts to shore up finances.

A key measure for evaluating MLPs is the yield which typically represents a significant portion of total yearly gains for an investor. The yield on the Alerian MLP index has plunged from well into double digits earlier this year to 8.30%, close to yields during ordinary times (around 7%). The premium of the MLP Index over the yield on the Treasury 10 year bond has come down to 460 basis points. Even though this spread is still above the traditional spread of 200, its swift decline in recent months is troubling.

Many don't fully appreciate the disconnect between earnings per unit and the distribution. Enbridge Products (EEP) just announced earnings per unit for Q2 was up sharply to 88¢. Its distribution is 99¢. The difference is because the distribution comes from cash flow (earnings plus non cash charges such as depreciation). Enterprise Products (EPD) reported Q2 earnings per unit dropped 29% to 32¢ but their quarterly distribution was increased slightly to 54½¢. That disconnect disturbs to me.

The rapid rise of MLPs this year ignored the recession in the US which should be hurting their results. So far they have sailed through stormy seas without major disturbances. Most MLPs have at least maintained their distributions and the risk premium on their yield is returning to conventional values. MLPs are capitalizing on positive momentum which implies risk with their rapid price advance.

Disclosure: no positions

Comments

[TCM:]

Why didn't you use the same rationale for Enterprise as for Enbridge?
Take a look at EPD's press release. Distributable Cash Flow was 110% of the recently raised dividend. No reason to be "disturbed".

Jul 28 02:09 PM

[TJ Schoenlein:]

I'm a big fan of many MLP's. I've been sliced & diced by the banks, insurance companies and just about all other dividend paying companies this time around.
The only area that has kept my passive income whole had been the pipelines. (Nat/Oil)
Cash cow for a retired guy.. thank you MLP's.
Check out what I own and see for yourself .. if you are looking for passive income you need to have some money with these folks.
Long: NS, MGG, WPZ, ETP, ETE & MWE

Jul 30 05:42 AM

[maryanne:]

Avi, appreciate and look forward to your articles on MLPs. I scooped them up at the Nov and Feb bottoms. Dealing with schedule K is not that big a deal. These things are great, how come you don't have any positions?

Jul 31 02:59 PM