What Should MLP Investors Expect in 2010?

Includes: AMJ, KMP, SPP
by: Avi Morris

The performance for MLPs in 2009 can only be described as spectacular. The Alerian MLP Index, AMZ, gained an amazing 109, or 62%, while the comparable index, AMZX, gained 328, or 77%. From its low on March 9, AMZX more than doubled and both easily had their best year by a wide margin. MLPs are yield securities, the highest yield for the index in 2009 was almost 13% and then plunged to 7.4% by year end.



One year ago "risk averse" was the driving force in the markets. High yield securities were being dumped at any price, and that money was reinvested in "safe" investments, with US Treasuries receiving a lot of attention. The yield on the 10-year Treasury reached record lows near 2% while the 90-day Treasury bill had yields turning slightly negative on occasion. As stock markets recovered, risk was embraced and rewarded. Last year was one of the most brutal times for financial companies but MLPs, which are in constant need of more funds to finance expansion, were rewarded with a dynamic recovery.

MLPs (mainly) invest in pipelines and terminals to move oil and gas. Financing for expansion was readily available in 2009. For example Kinder Morgan (NYSE:KMP) set a goal of raising $1 billion by selling equity units to support added borrowings. That goal was accomplished successfully. However a few MLPs had a difficult time. Constellation Energy Partners (CEP) eliminated the distribution to concentrate on paying down debt. They were successful enabling them to refinance their loan with a larger loan. The units are in single digits, but CEP looks like it will pull through.

MLPs will have a major challenge in 2010 after the tremendous gains last year. Yields are a primary measure of value, the yield on the index has fallen to below 7-1/2%. The yield on the 10-year Treasury bond has been rising, approaching 4% narrowing the spread to a little over 3-1/2%. In prior years a 2% spread was considered necessary to cover the added risk for owning MLP units. The Alerian MLP Index reached its record at 342 in July 2007 taking the yield to under 5-1/2% (record low). Meanwhile the 10-year Treasury yield had risen to 5-1/4%, narrowing the spread to near zero. That turned out to be an important signal for selling MLPs despite their excellent track record.

Kinder Morgan has already announced its intention to raise the distribution from $4.20 in 2009 to $4.40 in 2010. In 2 weeks, 2009 MLP results will be announced along with Q1 distributions (which should include a number of quarter to quarter increases), and 2010 should be another good year for MLPs, with the economy in a recovery mode. A year of substantial unit price increases would reduce their yields and further narrow the yield spread over the Treasury's, a cause for worry. Present yields and yield spreads look to be reasonable, it's difficult to see major changes with only a modest recovery in the US economy. However, a significant pullback bringing higher yields during the year would provide a buying opportunity. MLP fundamentals remain strong as the US needs considerably more pipelines to transport energy products.

For those new to MLPs, there is an ETF with the symbol AMJ which tracks the Alerian MLP Index. It gives an investor a way to invest in a portfolio of securities by puchasing shares and avoid the tax hassle associated with owning units.

Disclosure: no positions