The First Metric MLP Investors Should Know - Part 4

 |  Includes: EPD, MMP, MWE, OKS, PAA, SXL, WPZ
by: Factoids

This article is about setting a specific number on a very nebulous but most important stock valuation. It is about price implied CAGRs (Compound Annual Growth Rate of the distribution). It is my valuation theory that almost all income generating stocks sell at a logical yield plus (discounted) CAGR metrics with some significant adjustments for risk. If you can generate your own CAGR projections with help from projections from multiple sources; use credit agency ratings and distribution/DCF ratios to set your risk assessments; and calculate your own price implied CAGRs; then you will have numbers to use in making the decision as to whether a stock is under valued, fairly valued, or over valued. You can at least partially exit the world of borrowed opinions where most investors reside. You can make your own valuations for "that doggie in the window" and determine if it is a good buy based on the comparison between your expected distribution growth and the amount of distribution growth that is already priced into the stock.

Before we get started, let's review where we have been

In part one I provided data and text on:
(1) Where can I find good dividend and distribution CAGR projections?
(2) Is there evidence that CAGRs strongly influence yields?
(3) Is there evidence that higher CAGRs sell at a discount?
(4) Is there evidence that CAGR awareness adds to total returns?

Part two provided data and text on:
(5) How volatile are CAGR projections?
(6) How many CAGR projections do I need to gather?
(7) What metrics or attributes should I use to double check a CAGR projection?
(8) Are the CAGR projections accurate enough to use in investment decisions?

Part three provided historical data over the last 24 months to answer
( 9) Did the high CAGR choices work to steer you to the best options?
(10) Did the low CAGR choices succeed at steering you away from the worst options?
(11) Did the average CAGR projections also result in close to average unit price appreciation?
(12) Did the Yahoo Finance EPS CAGRs appear to be a much help in setting correct CAGRs or in finding the best investments?
(13) Would a consensus CAGR projection be a better tool in selection than "ratings"?

In this article I will focus on the following question.
{14} How are price-implied CAGRs calculated? I will go through a quick intro to the dividend discount model. I will use bond ratings as the primary source to set interim required rates of return. One of the goals of the whole process is to provide you with another source of CAGR projections. I will share some data that I expect you will want to see. A byproduct of this process is to help you see why there are significant yield spreads in this sector. I will argue that the spreads in those yields should be wider.

In another part of this series I will address the question "How can price-implied CAGRs be used in an investment decision?" Once the price implied CAGR calculation is explained, the answer to this will be obvious. Sooner or later, I expect to address the generic question "how much CAGR is enough?" for investors in early retirement and those approaching retirement. I expect to do a short - but controversial - series on risk which will contain two or more must-see spreadsheets. I will end with my portfolio suggestions for MLP newbies. If you are reading this series to pick up suggestions - you are missing the point. I am trying to free you from needing borrowed opinions.

For most investors, a price is just a price. Most investors need to evolve. I believe that there is information within a stock's price that tells us about the market's growth assumptions for that stock. And that information can be derived by using the dividend discount model to generate a price implied CAGR.

When one puts the obvious into words, the lightly wrinkled obvious starts to sound complicated. Put the words into a formula, and the obvious really appears complicated. Keep your focus, and it all stays simple. This is one of the parts of my due diligence process where I have had a tendency to lose people.

The Dividend Discount Model (or "DDM") is a simple formula to arrive at a valuation given specific conditions. The DDM model price = dividend yield divided by the difference of a required rate of return minus a compound annual growth rate of the dividend. It is often express as P=D/[R-G] where P is price, D is dividend, R is a required rate of return and G is the growth rate of the dividend. In the formula below, R is changed RRR (required rate of return) and G is changed to CAGR (Compound Annual Growth Rate projection for the distribution).

I do not want you to memorize the formula. I want you to believe in the formula. We are going to start with what we know - and deduce the formula in a short series of steps. I would like you to arrive at the conclusion that the DDM is a formula that states the obvious. We can be intimidated by formulas. For some of you, the formula is a molehill. For some, the formula is a mountain. The nest section of this article is specifically written for those for whom it is a mountain. But it is a mountain that we can downsize. This will all become obvious. And we are not intimidated by the obvious.

For bonds that have a constant dividend, the yield of a specific investment equals yield of the safest investment plus yield increment adjustment due to added risk of a specific investment. Put in plain English, riskier bonds should have yields that are higher than safer bonds.

For inflation protection bonds and for stocks with a growing dividend, the yield of a specific investment equals "yield of the safest investment plus the yield increment adjustment due to added risk of a specific investment" minus the "yield decrement due to added dividend growth of a specific investment." Put in plain English, stocks with higher dividend growth will tend to have lower yields than stocks with slower growth - or no dividend growth.

The "yield of the safest investment + yield increment adjustment due to added risk of a specific investment" would be the Required Rate of Return for a given investment. The "yield decrement due to added dividend growth of a specific investment" would be the Compound Annual Growth Rate for a given investment. All I have done is put shorter labels on a longer string of words.

Put in other words: the yield or yearly dividend/price ratio = "Required Rate of Return" - "Compound Annual Growth Rate." Using the acronyms to put that into a formula: Div/Price = RRR - CAGR. We will, in a minute, look at some real world data to verify "Div/Price = RRR - CAGR." For now, let's keep on going.

The DDM is a permutation of this "Div/Price = RRR - CAGR" formula. It is a two step process to get to the DDM.
(1) Multiply both sides of the equation by "price" to get Div = price times (RRR - CAGR]
[2] Step two: Divide both sides of the equation by "(RRR - CAGR)" to get div / (RRR - CAGR) = price. And that is the dividend discount formula.

Those last five paragraphs ran by quickly. There was not a lot to explain. It was all so obvious. The obvious does not need the ornamentation of lots of explanation. On the other hand, the obvious put into the form of a formula is powerful. You need to have followed the above - and comprehended it one hundred percent. Re-read those short paragraphs until you do.

The DDM is used to solve for an unknown model price given a known RRR and CAGR. Using the same formula, we can solve for the unknown price implied CAGR using a current known price and a known CAGR. Let's now take a few steps back when "Div/Price = RRR - CAGR" and solve for CAGR. We need to add a positive CAGR to both sides of the equations to get "CAGR - Div/Price = RRR." We need to subtract Div/Price from both sides of the equation to get to "CAGR = RRR + Div/Price."

Now for the promised pause to verify "Div/Price = RRR - CAGR." If the formula is true, then lower risk investments would have lower yields. Is that the case? Also, if the formula is true, then higher CAGR projections would also result in lower yields. Is that true? The truth is in the data. Let's see the current data:

The relationship between CAGR projections and yields: While yields are also influenced by risk, the dominance of the influence of dividend growth projections can easily be seen.
The following had CAGR projections over 8.5%: APL, ACMP, GEL, MMP, MWE, PAA, SXL and WES. Their current average yield is 4.39%.
The following had CAGR projections under 8.5% but over 5.9%: DPM, EPD, HEP, NGLS, OKS, SEP and XTEX. Their current average yield is 5.52%.
The following had CAGR projections under 6.0% but over 3.5%: BPL, EPB, ETP, KMP, RGP, TLP and WPZ. Their current average yield is 6.48%.
The following had CAGR projections under 3.5%: BWP, CMLP, EEP, EROC, EXLP, NS, TCP, NMM, MMLP and TGP. Their current average yield is 8.42%.

The relationship between credit ratings and yields: The influence of credit ratings can be seen with the naked eye. There is one problem - each rating grouping fails to have close to the same average CAGR projection - so these stats over emphasize the important of risk on yield based on current market valuations.
The following midstream companies had their S&P corporate credit ratings equal to BBB+ or BBB: BWP, EEP, EPD, KMP, MMP, OKS, PAA, SEP, TCP andand WPZ. Their current average yield is 5.77%.
The following companies had corporate credit ratings of BBB-: BPL, DPM, EPB, ETP, SXL and WES. Their current average yield is 5.34%.
The following companies had corporate credit ratings of BB+, BB or BB-: ACMP, GEL, HEP, MWE, NGLS, NS and RGP. Their current average yield is 5.81%.
The following companies had corporate credit ratings of B, B+, B- or were note rated: APL, CMLP, EROC, EXLP, TLP, XTEX, NMM, MMLP and TGP. Their current average yield is 8.10%.

The above data showed the yields by rating group. This data indicates the influence of risk on yield could be as high as 200 basis points. I strongly believe that there should be a wide or wider spread as shown in that data. But the rating groups varied by average CAGR. I will now show the "yields plus CAGRs" by rating group so that we can screen out to distorting influence that unequal CAGRs had on the above data.

The relationship between credit ratings and total returns: This data shows the influence of credit ratings on the combined yield plus distribution growth.

The relationship between credit ratings and total returns:
The following midstream companies had their S&P corporate credit ratings equal to BBB: BWP, EEP, EPD, KMP, MMP, OKS, PAA, SEP, TCP and WPZ. Their current average total return projection is 11.40%.
The following companies had corporate credit ratings of BBB-: BPL, DPM, EPB, ETP, SXL and WES. Their current average total return projection is 11.64%.
The following companies had corporate credit ratings of BB+, BB or BB-: ACMP, GEL, HEP, MWE, NGLS, NS and RGP. Their current average total return projection is 12.38%.
The following companies had corporate credit ratings of B, B+, or B-: APL, CMLP, EROC, EXLP, XTEX and MMLP. Their current average total return projection is 12.75%.

Using this data, it is easy to see a 100 basis point difference in the yields can be accounted for by the risk assessment. Ironically, after downsizing the importance of risk in the above data on current valuations, I am going to upsize the importance of risk in upcoming data.

You have now had the DDM formula explained. You have seen some of the data that supports the simple assumptions. You now have a tool that will help you in evaluating every income investment. And you now have a new source - and a free source - for setting your CAGR projection expectations. We now need to take a quick tangent.

There are big problems with applying the DDM to MLPs and my above description of it
The model works when the growth rate is constant in perpetuity. My CAGRs are conservative 5-year projections where high projects are almost always going to fall. The model intends to use R as "the cost of equity" and not a risk assessment like I am doing for the "required rate of return." My description fits how I use the DDM. My description is a very faulty explanation compared to what an academic would do when describing the DDM.

The DDM is also called the Gordon growth model. It is named after Myron J. Gordon of the University of Toronto, who originally published it along with Eli Shapiro in 1956. P is the current stock price. G is the constant growth rate in perpetuity expected for the dividends. R is the constant cost of equity for that company. In some forms of the formula, D is the sum of the present value of the dividend into perpetuity.

In sum, I have given you a description of the DDM that is not compatible with descriptions found elsewhere. You will have to take my word that this twisting of the DDM is not something unique to me. I did not discover this kind of twisting. I copied it from how it is used by the analysts. The DDM only works with perpetuity CAGRs. The analysts handle this obstacle by creating a multi-stage DDM in calculating the MLP target prices. They also average that output with the output of a price at a logical DCF multiple model - where risk and growth are used to set varying multiples for each MLP.

The unfairness of it all
Why do some stocks have higher assessments for their required returns, and others have lower assessments? On the surface, that does not sound fair. If you are creating a system for the valuation of stocks, one should certainly strive for fairness. You do not want your personal biases to cause you to overlook a potential winner. Winners can be few and far between. You can not afford to miss that many. When one sets different risk assessments for stocks in the same sector, you are creating bigger hurdles for some stocks - and smaller hurdles for others.

One can replace the questions of "why are the hurdles of different sizes?" with "why can't all stocks have good debt to market cap ratios?" to answer that question. "Why can't all stocks pay the same safe proportion of DCF to distribution ratios?" helps answer that question "Why can't all stocks have high proportions of fee based income and low proportions of commodity sensitive income?" helps answer that question. "Why can't all companies avoid unpleasant earning surprises" helps answer that question. Each company is different. That is my case for why the sizes of the hurdles vary. I now need to justify that I have correctly accounted for the sizes of those differences - which is a harder task.

Here are my current RRR's for my midstream coverage universe
Yield + CAGR Total Return Expectations

Company Q3-13 Consensus Total Bonds My Total Rtn Consensus Pr Impl Distrib
Yield CAGR Return Ratings RRRs - RRR Ratings CAGR / DCF
Large Cap Midstream
Buckeye BPL 6.17% 4.10% 10.27% BBB- 10.40 -0.13 2.5 4.23 98.15
Boardwalk BWP 7.19% 2.00% 9.19% BBB 10.00 -0.81 2.9 2.81 103.40
El Paso EPB 6.01% 5.50% 11.51% BBB- 10.40 1.11 2.9 4.39 92.99
Enbridge EEP 7.34% 2.70% 10.04% BBB 11.00 -0.96 2.5 3.66 113.82
Enterprise EPD 4.45% 6.70% 11.15% BBB+ 9.70 1.45 1.7 5.25 70.65
Energy Trans ETP 6.75% 3.50% 10.25% BBB- 10.50 -0.25 2.5 3.75 94.58
Kinder Morgan KMP 6.36% 5.50% 11.86% BBB 10.00 1.86 2.7 3.64 97.78
Magellan MMP 3.85% 8.80% 12.65% BBB 10.00 2.65 2.5 6.15 82.24
NuStar NS 10.03% 1.50% 11.53% BB+ 11.60 -0.07 3.3 1.57 124.08
OneOK OKS 5.81% 6.50% 12.31% BBB 11.00 1.31 3.0 5.19 100.70
Plains All-Am PAA 4.21% 8.50% 12.71% BBB 10.00 2.71 1.9 5.79 72.09
Williams WPZ 7.13% 5.40% 12.53% BBB 11.00 1.53 2.3 3.87 108.15

Average 0.60% 5.06% 11.33% 2.56
Small Cap Midstream
Company Q3-13 Consensus Total Bonds My Total Rtn Consensus Pr Impl Distrib
Yield CAGR Return Ratings RRRs - RRR Ratings CAGR / DCF

Genesis GEL 4.10% 8.50% 12.60% BB- 11.80 0.80 1.8 7.70 75.56
Holly HEP 5.21% 6.00% 11.21% BB 11.60 -0.39 3.3 6.39 97.00
Spectra SEP 4.92% 7.20% 12.12% BBB 10.00 2.12 2.9 5.08 96.91
Sunco SXL 3.74% 8.90% 12.64% BBB- 10.00 2.64 2.7 6.26 56.07
TCPipelines TCP 6.48% 3.00% 9.48% BBB 10.00 -0.52 3.2 3.52 89.75
Transmontaigne TLP 6.28% 3.50% 9.78% NR 10.00 -0.22 1.7 3.72 74.29

Average 5.12% 6.18% 11.31% 2.60

Company Q3-13 Consensus Total Bonds My Total Rtn Consensus Pr Impl Distrib
Yield CAGR Return Ratings RRRs - RRR Ratings CAGR / DCF
Gathering & Processing
Atlas Pipelines APL 6.71% 9.10% 15.81% B+ 12.50 3.31 1.4 5.79 84.35
Access ACMP 4.04% 9.60% 13.64% BB- 11.70 1.94 1.7 7.66 71.06
Crestwood CMLP 7.61% 3.30% 10.91% B- 13.00 -2.09 2.1 5.39 103.03
DCP Partners DPM 5.74% 6.50% 12.24% BBB- 11.60 0.64 2.1 5.86 97.26
Eagle Rock EROC 12.94% 2.50% 15.44% B 13.00 2.44 2.6 0.06 111.39
Exterran EXLP 7.16% 3.40% 10.56% B- 11.00 -0.44 2.5 3.84 75.45
Mark West MWE 4.81% 8.60% 13.41% BB 12.00 1.41 1.7 7.19 96.55
Targa NGLS 5.78% 7.60% 13.38% BB 12.00 1.38 1.9 6.22 100.00
Regency RGP 6.67% 4.20% 10.87% BB- 12.00 -1.13 2.6 5.33 98.41
Western WES 3.66% 9.30% 12.96% BBB- 11.20 1.76 1.9 7.54 89.60
Cross-Tex XTEX 6.70% 7.50% 14.20% B+ 12.50 1.70 2.3 5.80 92.31

Average 6.53% 6.51% 13.04% 2.07

Click to enlarge

My required rate of return guesstimates are predominantly based on bond ratings - and slightly adjusted to reflect information generated by a search for current bond yields. The spreads in the RRRs should be roughly correlated to the spreads on bond yields. They also are adjusted by sub-sector; with midstream MLPs having lower requirements than gathering and processing MLPs. G&Ps with higher fixed-fee income have lower requirements. Some RRRs are adjusted to be in alignment with analyst "discount rate" numbers. Some RRRs are adjusted to be in alignment with debt to market cap and debt to EBITDA ratios. Transmontaigne (NYSE:TLP) has non-rated debt. At the same time, it has an atypically low debt to market cap. TLP's and Exterran's (EXLP) adjustments for that attribute sticks out in the RRR assessments. To a smaller degree, the same RRR upgrade was done for Sunoco (SXL). Some RRRs are adjusted to be in alignment with an atypical distribution to DCF ratio. Poor distribution coverage adds to the risk assessment. OneOK (NYSE:OKS) and Williams (NYSE:WPZ) currently have RRRs that have been adjusted for that negative attribute. Those adjustments should be temporary. The numbers are then verified by observing the quality of their price-implied CAGRs that they generate - and whether those price implied CAGR spreads to my projections are in alignment with analyst ratings. Highly rated stocks should strongly tend to have price implied CAGRs that are lower than the consensus CAGR projections. I want to generate RRR data that is echoed by the ratings of the analysts - but I do not strive for 100% correlation. I want data that provides an indicator of when the analysts might be wrong.

An example of this would be the comparison between Magellan Midstream Partners (NYSE:MMP) and Plains All American Pipeline (NYSE:PAA). The total return projections are within 6 basis points of being equal, while the stock ratings are relatively distant. A 36 basis point difference in yield is a strong reason for the difference in ratings. As a rule of thumb, price appreciation slows once the yield falls below 4%. But MMP is projecting great distribution growth. MMP lacks IDRs or incentive distribution rights. PAA pays IDRs to its GP. MMP has the better inertia. MMP has significantly better DCF growth projections. Both are very good portfolio components. Both have very good distribution/DCF ratios. Both have very good DCF projection accuracy - a metric that I will explain when I talk about risk. The market says that MMP merits having the noticeably lower yield - and I agree with the market. Price appreciation will only come with distribution growth. I can live with 15% price appreciation and a 3.85% yield. I believe that kind of performance merits a higher analyst rating. I believe that MMP and PAA should have nearly equal ratings.

I am frequently making minor adjustments to these RRR stats. I am always finding small problems. A reader could correctly nitpick on a dozen of these assessments. I focused on getting the numbers perfect when I am comparing two stocks for potential purchase. I am only attempting perfection for those two stocks. When - or if - the reader attempts to duplicate this task, he or she will also have a smaller universe to master. I would not expect another individual retail investor to duplicate this effort for RRR assessment for the full sector. I am hoping for some tolerance with the faults that can be found in my effort.

When the stock is fairly valued, the RRR = Yield + PI-CAGR. We should intuitively know that - given the volatility of the market - next to nothing is fairly valued. Any system that independently assesses a CAGR and a RRR is going to find errors in the market valuations. This data is suggesting a lot of errors. Any system that fails to heavily discount CAGRs will generate data that implies that high CAGR stocks are under valued. I have only discounted CAGRs lightly via my conservative CAGR assessments. My data still shows that high CAGR options are under valued. Historical data strongly tends to show this is the case. You should also see that the Consensus CAGR - Price Implied CAGR = Total Return - RRR. Why? It is because both are calculations of a variance from fair value.

Total Return - RRR generates output that forecasts the error in the yield. An error of "1.00" is big. I will use the example of a $100 dollar stock paying a $6.25 distribution. The yield would be 6.25% - which is close to the sector average. If such stock had a Total Return - RRR of plus one - this valuation judgment would suggest that the yield is low by 100 basis points. For a $100 stock to fall from a yield of 6.25% to 5.25%, the price would need to rise to roughly $119. (The math: 6.25 divided by 119.00 = 5.2521%.)

Let's compared the RRR's with data for MLP bond offerings with a 10-year maturity done so far in 2013. Be forewarned - I will call this data from a recent report of a major brokerage "bad" data in a minute.

2013 MLP Debt Offerings with 10-year Maturities

Date Issuer S&P Moody's Rate

1-07-13 MWE BB Ba3 4.50%
1-07-13 SXL BBB- Baa3 3.45%
1-14-13 ETP BBB- Baa3 3.60%
1-28-13 APL B+ B2 5.88%
2-21-13 KMP BBB Baa2 3.50%
3-11-13 DPM BBB- Baa3 3.88%
3-11-13 EPD BBB+ Baa1 3.35%
4-24-13 RGP BB B1 4.50%
5-09-13 NGLS BB Ba3 4.25%
6-03-13 BPL BBB- Baa3 4.15%
Click to enlarge

The spread between the Atlas Pipeline Partners (NYSE:APL) and the Enterprise Products Partners (NYSE:EPD) bond offering is only 253 basis points while the spreads between my required rates of return for the equities is 310 basis points. It is my perception that we are currently in a relatively "risk-off" environment - and credit spreads on bonds between companies with different risk attributes is relatively low. I have not collected a sufficient history of bond data to support that perception. Still, with the handicap of a large spread in the equity required rates of return, the total return minus required rate of return metric currently suggests that APL is a superior value to EPD. That would imply that the market is currently requiring a bigger RRR spread between the two than my metrics are suggesting.

Even with the excuse that the market is setting higher hurdle differences than I am setting, I am aware that there are also cases where the opposite is true. I am intentionally setting high hurdles for the riskier MLPs in order to produce data that leads me to buying safer options. So I am willingly letting my personal temperament influence that data I am producing in order to generate an outcome that my temperament wants. It is my expectation that everybody does this. For your benefit, I did want to confess that there is this bias in my data. But it is "my" data - and that's the way I like it.

But - when I compared my RRRs with data from a site that allows us to look up current yields for existing bonds, my spreads begin to look too conservative. Yields on the 10-year Treasury began the year at 1.76%. The current yields for 10-year bonds are close to 2.6%. The date of the bond offering plays a huge role in the coupon rate at which the bonds are set. The above data on year-to-date bond offerings does not take that timing factor into account.

Bond data from FINRA web site on 8-05-13

Comp Source CUSIP Price Yield Maturity
Short Maturities
APL APB.GC 04939MAC3 $104.060 5.920% 12/15/2015
BPL BPL.GF 118230AD3 $105.437 0.749% 10/15/2014
BWP L3703461 882440AS9 $104.893 1.871% 06/01/2015
EPD EDP3667070 293791AR0 $106.303 0.944% 03/01/2015
MMP MMP.GA 559080AA4 $104.890 0.558% 06/01/2014
MMP MMP.GB 559080AB2 $114.039 1.361% 10/15/2016
KMP KMI3675344 494550BA3 $107.203 0.852% 02/15/2015
OKS OKE3688619 68268NAF0 $104.231 1.448% 02/01/2016
WPZ WMB.JE 893570BW0 $114.142 1.105% 04/15/2016
9 Year Maturities
ACMP CHKM3836735 16524RAE3 $103.500 5.471% 07/15/2022
DPM DPM3829889 23311VAB3 $102.711 4.559% 04/01/2022
EPD EDP3695098 29379VAU7 $101.597 3.828% 02/15/2022
EEP EEP3696243 29250RAU0 $102.823 3.781% 09/15/2021
ETP ETP.AA 29273RAQ2 $106.394 4.270% 02/01/2022
KMP KMI3829314 494550BL9 $99.665 3.994% 09/01/2022
MMP MMP.GG 55907RAA6 $105.662 3.387% 02/01/2021
MWE MWE.GK 570506AP0 $105.750 5.174% 06/15/2022
NGLS NGLS3964295 87612BAK8 $106.000 5.269% 08/01/2022
PAA PAA3831124 72650RAZ5 $100.175 3.625% 06/01/2022
SEP SE3692607 84756NAB5 $104.713 3.882% 06/15/2021
TCP TRP3692939 87233QAA6 $102.588 4.248% 06/15/2021
WES APC3691578 958254AA2 $108.181 4.105% 06/01/2021
WPZ WMB3699224 96950FAH7 $99.268 4.104% 11/15/2021
High Risk MLPs
BBEP BBEP3951154 106777AD7 $101.750 7.525% 04/15/2022
EROC EROC.AC 26985UAB3 $102.975 7.458% 06/01/2019
EVEP EVNT3815264 26926XAB9 $101.500 7.521% 04/15/2019
LINE LINE3696401 536022AF3 $101.705 7.340% 02/01/2021

Click to enlarge

FINA = Financial Industry Regulatory Authority

The spread between the APL and the EPD bonds of short maturity dates is 493 basis points while the spreads between my required rates of return for the equities is 310 basis points. The EPD bond matures several months sooner. That has an impact on the spreads. It is also the case that bond data can be flakey. The FINRA site displays data on the last sale, and that trade could have occurred at an atypical price. Given the lack of frequent trades on some bond offerings, flakey prices happen. The APL price and yield info in the above data looks flakey to me.

The yield spread between the MarkWest Energy Partners (NYSE:MWE) and the EPD bonds of longer maturity dates is 135 basis points while the spreads between my required rates of return for the equities is 230 basis points. The spreads between the 2013 issued bonds is 115 basis points - but timing shrank that spread. With a total return - or yield plus CAGR - spread of 234 basis points, the market appears to echo something close to a 230 basis point RRR spread. If you are finding that argument hard to buy, then let me keep on selling my RRR spread assessment with more information.

Equity ratings are also a factor. Both MWE and EPD are having consensus analyst ratings using the numbering system found at Yahoo Finance of 1.7. They are both viewed as having attractive valuations. In such cases, the total return spread should be close to the required rate of return spread.

The yield spread between the Targa Resources Partners (NYSE:NGLS) and the EPD bonds of longer maturity dates is 144 basis points while the spreads between my required rates of return for the equities is 230 basis points. The spreads between the 2013 issued bonds is 75 basis points. With a total return - or yield plus CAGR - spread of 212 basis points, the market appears to echo something closer to my educated guess at a RRR spread than you would get by comparing yield spreads.

Both MWE and NGLS have bond ratings of BB while EPD has a rating of BBB+. I strongly believe that there should be a significant spread in the required rates of return given that difference. There is one other piece of data that supports this conclusion. Look at the price implied CAGR spreads for NWE and NGLS. Both sell at price implied spreads that are slightly lower than their consensus CAGR projections. And that results in them being well rated by the analysts. If I were to significantly lower their required rates of returns, their price implied CAGRs would fall to a point that I would no longer feel comfortable setting those bullish projections. I am more comfortable producing data that indicates the market is slightly wrong - and not data that would indicate that the market is significantly wrong.

Eagle Rock Energy Partners (NASDAQ:EROC) has a bond rating of B. The spread between the EROC and the EPD bonds of longer maturity dates is 363 basis points while the spreads between my required rates of return for the equities is 330 basis points. Other E&Ps are priced at similar yields. With a total return - or yield plus CAGR - spread of 276 basis points, the market appears to echo something close to a 363 basis point RRR spread. The current total return spread is too low, and that shows up in EPD having a significantly better equity rating compared to EROC at a 2.6 rating.

I have briefly covered one of the risk-related metrics that assist in setting an interim required rate of return that I use to generate a price implied CAGR. I will cover many more metrics on risk in a separate article. We have lightly touched on risk - there is much more yet to come on that topic.

Let's review. I have written about bond spreads, RRR spreads, total return spreads, bond rating spreads and equity ratings spreads --- while showing data on CAGR spreads and equity yield spreads. Some of you may have contemplated spreads on data that you did not even know existed. I have done this to justify that my data is close enough to correct to use in an investment decision. I have provided a lot of text to assist you in repeating the process on your own. It is now time to use this data in an investment decision - but that topic will have to wait till my next article.

Disclosure: I am long CMLP, DPM, EPB, EPD, GEL, KMP, MMP, MWE, WES. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.