I decided to take last week off and visit our son and some friends in South Carolina. Before leaving, I promised myself that I would limit my investment activities to a few brief market checks on my iPhone each day. The break would help me to clear my head a bit while getting me away from my six hour days at the computer screen.
WOW, did I miss a lot!
Since the MLPs constitute a significant weighting within the Protected Principal Retirement Strategy portfolio, and since last week was filled with mostly negative news on this asset sector, I will use this article to provide an update on our positions, and my thoughts on our upstream MLPs in particular.
The week was dominated by news surrounding (LINE) and (LNCO) and the pending SEC inquiry. The situation was exacerbated by an SA article referring to some of the MLPs as "Ponzi Schemes" and by reports that a firm named "Hedgeye" was shorting both stocks, plus trashing Breitburn Energy Partners (BBEP). Let me say unequivocally that in my opinion MLPs are a long term investment (I have been buying them since 2004), that I believe that overall the sector is a good place for income investors, and that such amusing articles and companies recommending shorting these stocks only provide new buying opportunities for the "best of breed" upstream and midstream MLPs.
We do not hold either LINE nor LNCO at this time. I have followed both for some time and believe that selling has been way overdone. However, until the dust clears I will continue to be on the sidelines.
We currently own a few upstream MLPs (those primarily focused on exploration and production of oil, natural gas and natural gas liquids). These include: Breitburn , Memorial Production Partners (MEMP), New Source Energy Partners (NSLP) and Vanguard Natural Resources LLC (VNR).
Of these, I am most partial to VNR since it pays a monthly distribution, seems to have a superior business model, and has continually increased the amount of the distribution since its trading inception in February 2008.
BBEP is also an upstream [MLP] that I particularly favor since its holdings span a good portion of the U.S. (the upper midwest, the west, the far west, southwest, and even Florida). While not as prolific as VNR relative to increasing the distribution, BBEP has continued to increase it since cutting it in May 2010.
Insofar as adding to our upstream positions I am comfortable with our present levels of commitment to both MEMP and NSLP (having recently increased this position a bit). Having been away last week I have to admit my vacation timing might have been bad relative to expanding positions in both VNR and BBEP. Both hit lows on July 5 - VNR at $24.23 and BBEP at $14.01. Both recovered somewhat on the same day with VNR closing at $25.57 and BBEP at $15.24.
At present pricing, VNR has a yield of 9.6 percent and BBEP a yield of almost 12.5 percent.
With the LINE/LNCO situation still dominating the [MLP] news front, and with Hedgeye trashing BBEP, I have decided to step back for a few days while closely watching both VNR and BBEP's performance early this week. Both are trading up pre-market as I write this article Monday morning.
I would like to eventually add to both, preferably to VNR under the $25 level, and to BBEP under $15.
While I think it is prudent to own a few upstream MLPs (one never knows when the Middle East is going to explode - no pun intended), the midstream (pipelines and infrastructure) sector is much more stable since it is supposedly not as sensitive to the price of the underlying commodities.
We currently hold Crestwood Midstream Partners (CMLP), Enterprise Products Partners (EPD), and Crosstex Energy (XTEX). EPD is far and away our largest position, having owned Teppco Partners when EPD acquired them.
There are several midstream MLPs on my watch list including: Access Midstream Partners (ACMP), DCP Midstream Partners (DPM), Plains All American Pipeline (PAA), Targa Resources Partners (NGLS), Southcross Energy Partners (SXE), and a relative newcomer, Tallgrass Energy Partners (TEP). I consider ACMP, DPM, PAA and NGLS to be the best of this bunch; however, the current yield of each does not meet our portfolio's criteria of seven to eight percent. Since the midstream sector seems to be the safest place to be I may begin to re-think lowering the yield criteria a bit to accomodate the faster growing midstream MLPs in return for a higher total return.
I use the compound annual growth rate [CAGR] to assist in my evaluation of MLPs. This, in conjunction with distributable cash flow [DCF] and the coverage ratio gives me a quick overview of potential future performance. The CAGRs provided by Yahoo Finance I believe are based upon earnings growth and not dividend growth. However, I follow the [MLP] board on iVillage which, from time to time addresses distribution CAGRs.
For information purposes, here are the CAGRs (form Yahoo Finance) for the midstream MLPs mentioned above:
- CMLP - 16.6%
- EPD - 5.5%
- XTEX - 9.0%
- ACMP - 20.5%
- DPM - 13.3%
- PAA - 5.1%
- NGLS - 25.5%
- SXE - 5.0%
- TEP - N/A (Fairly new)
I look for a CAGR greater than 5 percent for the MLPs.
I want to take a closer look at the two newer midstream MLPs in this article, since I believe the yield opportunity of one meets our portfolio criteria, and the potential exists for the yield of to increase over coming quarters.
SXE: Southcross is predominantly a midstream MLP whose pipelines transport primarily natural gas and natural gas liquids. It operates in Texas, Mississippi and Alabama. It also has downstream operations involving the sale of propane, butane and gasoline. Operations are presently focused on the Eagle Ford shale region. For the first quarter 2013, earnings, distributable cash flow [DCF] and coverage were disappointing. The company attributed this to heavy start-up costs of a new fractionation facility.
DCF declined (year over year) from over $10 million in 2012 to just over $2 million in 2013. It paid $9,973 million in first quarter distributions while DCF was only $2,035 million.
According to its conference call, SXE's expectations for the balance of 2013 are quite positive, and it would appear that the quarterly distribution of $.40 is a safe bet.
Personally, I will continue to watch SXE and would put off any purchase I would make until second quarter earnings have been released.
TEP: Tallgrass IPO'ed in mid-May of this year. Its pipeline assets are located primarily in the midwestern states of Nebraska, Kansas, Missouri, Colorado and Wyoming. It transports primarily natural gas and natural gas liquids, and also operates processing facilities.
For the quarter ended in March 2013 adjusted EBITA declined (year over year) from $23,195 million in 2012 to $19,100 million in 2013.
TEP generated $17,145 million in DCF in the first quarter, for a coverage ratio of 1.44x. It anticipates that for the full year (2013) the DCF coverage ratio will be somewhere around 1.2x.
All things being equal, it is my preference to add to the Protected Principal Retirement Strategy portfolio's midstream MLPs. High [CAGR] MLPs like ACMP, DPM and NGLS would fit the bill perfectly, if prices declined to the point where yields got into even the six percent range.
Of the two midstream MLPs discussed in greater detail, TEP looks the most attractive and analyst price targets are in the $23 - $24 range. It currently pays $.2875 quarterly, which equates to a current yield of about 5.4 percent. It will be interesting to see if the distributions are increased in coming quarters.
Looking at the upstream sector I want to wait until all of the recent fallout clears, as there might well be additional downside potential. My clear first choice would be to add to current positions, first in VNR, and then possibly in BBEP.
Additional disclosure: This article does not constitute either a buy or sell recommendation for any of the stocks mentioned.