We all know that bonds of the same maturity sell at different yields based on risk. We all intuitively know that risk is an influence on pricing MLPs (Master Limited Partnerships) and other income producing equities. Those of us who are CAGR (projected Compound Annual Growth Rate) aware can see with our own eyes that not all stocks with given dividend or distribution CAGRs sell at the same yield. Examples: Large-cap midstream stocks with 6% CAGRs sell at lower yields than G&Ps (Gathering and Processing) with the same CAGRs because their DCFs (Distributable Cash Flows) are less commodity sensitive. REITs (Real Estate Investment Trusts) with 4% CAGRs sell at lower yields than MLPs with 4% CAGRs - because REIT contracts would be like a 100% fixed fee MLP - and the higher the fixed fee component of income, the lower the yield for the MLP. We all intuitively know that earnings visibility and volatility is an influence on the risk assessment that influences valuation. We know that risk matters. But we are really shy when it comes to talking about it. We are even hesitant to think that much on the topic.
We retail investors do not know how (because we have never been "authoritatively" told how) to quantify risk. And because we cannot quantify risk, we cannot see the size of the influence that risk has on valuations. We just know that the pricing for risk "is in there" as one of the factors that influence the pricing of an equity. We do not know the size of influence that is supposed to be "in there". And we cannot determine the size of the influence that is currently "in there" to compare it to the amount that is supposed to be "in there".
To be risk aware, I primarily use three metrics: earnings projection accuracy, current year earnings projection spreads (or the proportional size of the difference between the high and low projection) and credit ratings. I attempt to size risk. I attempt to quantify a risk assessment and use that metric in my valuation assessment. I believe I am the only one out there writing about the correlation between RRRs (required rates of return or the quantification of a risk assessment) and "historical earning projection accuracy" and "current year earnings projection spreads". I strongly believe that those two metrics are important because we need multiple inputs (or something other than bond ratings) to go into our risk assessment. In looking at the imperfect correlation between bond ratings and what I believe to be the correct RRRs - it is apparent to me that there is more to an equity RRR assessment than the bond rating. That should not come as a surprise. In looking at yields of the same maturity, there is more to bond pricing than bond ratings. To me, it is intuitive to think of income producing equity valuations in the terms of "yield + CAGR - RRR". If one has failed to see the correlation between "yield + CAGR - RRR" and analyst ratings -- then you just are not looking hard enough. It is my current impression that I am the only person writing about a "yield + CAGR - RRR" metric. And that is also not surprising, because it is hard to find anyone writing about risk quantification or RRRs.
Why is there a de facto conspiracy of silence when it comes to risk quantification?
If risk is important, then why isn't anyone talking about it? First off - "they" are talking about. But they are using lingo you do not understand in reports you seldom read. You can find the analysts from the brokerages writing about it in their footnotes and in some spreadsheets. Wells Fargo lists their "required rates of return" for each MLP in the footnotes at the end of their sector updates. Morgan Stanley provides "discount rates" in one of their spreadsheets. UBS provides a "cost of equity" metric in their evaluations. But these are the exceptions. Most brokerages provide metrics that can assist you in making a risk assessment like debt to market capitalization or debt to projected EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortizations). Some brokerages will provide a projection of the fee component percentage of income. But it is hard to find metrics to assess earnings visibility and volatility. Credit metrics alone fail to address the issues of earnings visibility and volatility.
It is my current perception that historical earnings projection accuracy is the best metric to do that. You are getting a really good substitute for that from Wells Fargo, Morgan Stanley and UBS in their required rates of return, discount rates and cost of equity. But you are not getting the real thing. Why? Showing earnings projection accuracy would be misused by investors as measure of how wrong the analysts were. That is not the way the metric should be used.
It is my observation that the analysts echo the projections provided to them by the companies. Analyst projections change when the company guidance changes. That is the way it is in sector after sector. And that leaves the analyst with a terrible defense if investors were to use "historical accuracy numbers" as evidence that the analysts were wrong. The analysts are coping the answers off of someone else's homework. They should not be judged for the accuracy of their answers because "their answers" were not "their answers" to start with. They were someone else's answers! So don't blame them if the answers are wrong. In summation, we are not going to get historical accuracy numbers from the brokerages because they lack a sellable defense for the cases where accuracy was poor.
Why isn't CNBC talking about risk quantification? First: Because they never have segments over 8 minutes long. The subject is too complex to fit into an 8 minute segment. Second: CNBC exists because it can sell air time to advertisers that handle these kinds of complexities. If CNBC started providing enough information for you to make an intelligent decision about individual investments, they could lose all those ads from mutual funds, brokerages and ETFs. Third: A circular argument can be made - if no one is talking about risk quantification, then there is no news to report about risk quantification. If we are not first told that risk quantification is important, there is no demand for information of risk quantification. And fourth: CNBC is still silent on CAGR projection quantification. We are not going to talk about risk quantification before we talk about growth quantification - right? And CNBC is silent on CAGRs because of reason number two.
Why is it hard (or impossible?) to find other writers talking about risk quantification? Look in the mirror to find the reason. You are not asking for articles on risk quantification. And why are you not asking? Because no one is proving that risk (or earnings visibility and volatility) matters - and proving that such risk can be minimalized or avoided. The reader should be forewarned that after reading this article, you will lack an excuse for that kind of risk quantification agnostic behavior from now on.
What are the year to date numbers?
MLP Midstream 06-20-14
The consensus DCFs were last updated on 06-14-14. The CAGR projections were updated 6-14-14. Yields are based on the Q2-14 distribution. Under the 'year to date' header, the change in the distribution is the change since Q2-13 - or the change over the last twelve months. The change in the target, EPS, DCF and CAGR is the percentage change in the consensus 2014 projection that has happened since the beginning of the year.
|Company||Current||Distrib/||Q2 Dist||Dist/dcf||Dist/dcf||Year-to-Date Percent Change|
|Access Midstream Partners, L.P.||(NYSE:ACMP)||61.11||0.5750||3.76||70.12||66.47||8.01||10.04||-3.11||20.55||1.86||23.13||0.00|
|American Midstream Partners, LP||(NYSE:AMID)||29.53||0.4625||6.26||97.88||84.09||9.05||12.46||0.00||10.68||-8.70||6.94||40.00|
|Atlas Pipeline Partners, L.P.||(NYSE:APL)||33.00||0.6200||7.52||91.85||85.22||-5.85||-2.31||-95.24||-14.75||-8.47||5.08||4.29|
|Blueknight Energy Partners, L.P.||(NASDAQ:BKEP)||9.10||0.1300||5.71||67.53||55.32||6.93||9.99||-56.60||0.00||-25.24||10.64||2.35|
|Buckeye Partners, L.P.||(NYSE:BPL)||80.04||1.1000||5.50||95.86||87.30||12.72||15.81||-0.54||9.04||-2.34||4.76||20.00|
|Boardwalk Pipeline Partners, LP||(NYSE:BWP)||17.03||0.1000||2.35||24.24||23.67||-33.27||-32.48||-22.31||-39.45||-16.67||-81.22||0.00|
|Crestwood Midstream Partners LP||(NYSE:CMLP)||22.17||0.4100||7.40||93.71||84.97||-10.93||-7.63||-26.79||-7.01||-5.41||3.80||16.67|
|DCP Midstream Partners LP||(NYSE:DPM)||56.23||0.7450||5.30||93.71||83.94||11.68||14.64||-7.08||6.03||-3.34||6.43||4.48|
|El Paso Pipeline Partners, L.P.||(NYSE:EPB)||34.62||0.6500||7.51||97.74||95.94||-3.83||-0.22||-16.50||-12.15||3.10||4.84||8.70|
|Enbridge Energy Partners, L.P.||(NYSE:EEP)||33.85||0.5435||6.42||106.57||100.18||13.32||16.96||-14.29||3.10||-3.77||0.00||33.33|
|Enterprise Products Partners L.P.||(NYSE:EPD)||75.41||0.7100||3.77||67.62||64.99||13.74||15.88||5.03||11.83||1.20||5.97||0.00|
|Energy Transfer Partners, L.P.||(NYSE:ETP)||56.80||0.9350||6.58||81.30||83.86||-0.79||2.48||12.35||4.86||-1.92||4.62||8.11|
|EQT Midstream Partners, LP||(NYSE:EQM)||98.17||0.4900||2.00||57.65||46.12||66.98||68.65||21.76||47.53||9.68||32.43||1.05|
|Exterran Partners, L.P.||(EXLP)||28.50||0.5375||7.54||78.75||83.01||-5.72||-2.17||-41.27||7.00||4.60||3.86||0.00|
|Genesis Energy LP||(NYSE:GEL)||53.87||0.5500||4.08||78.85||67.90||2.47||4.57||-19.79||5.24||-5.10||10.55||4.65|
|Holly Energy Partners L.P.||(NYSE:HEP)||33.85||0.5075||6.00||89.43||83.20||4.70||7.84||5.08||1.78||3.65||6.28||0.00|
|Kinder Morgan Energy Partners, L.P.||(NYSE:KMP)||80.25||1.3800||6.88||97.87||94.68||-0.51||2.91||1.84||-5.11||-1.57||6.15||-31.91|
|Magellan Midstream Partners LP||(NYSE:MMP)||82.10||0.6125||2.98||72.27||66.04||29.76||31.70||18.71||34.57||10.42||20.69||2.27|
|MarkWest Energy Partners, L.P.||(NYSE:MWE)||68.01||0.8700||5.12||89.23||75.65||2.84||5.47||-45.68||-7.67||-10.14||4.82||-12.64|
|Targa Resources Partners LP||(NYSE:NGLS)||70.11||0.7625||4.35||77.02||73.49||34.05||36.97||55.63||17.50||12.82||9.32||7.25|
|NuStar Energy L.P.||(NYSE:NS)||58.79||1.0950||7.45||107.88||97.77||15.30||19.59||6.99||22.70||6.56||0.00||6.67|
|ONEOK Partners, L.P.||(NYSE:OKS)||56.34||0.7450||5.29||89.22||82.78||7.01||9.84||9.67||4.85||0.00||4.20||0.00|
|Oiltanking Partners, L.P.||(NYSE:OILT)||93.98||0.4950||2.11||58.41||51.03||51.41||53.00||-7.57||45.02||20.21||22.22||19.48|
|Plains All American Pipeline, L.P.||(NYSE:PAA)||58.06||0.6300||4.34||86.01||78.50||12.15||14.58||-8.24||3.49||-6.39||9.57||0.00|
|Regency Energy Partners LP||(NYSE:RGP)||30.64||0.4800||6.27||93.66||84.21||16.68||20.34||-5.77||6.42||-0.97||4.35||25.00|
|Spectra Energy Partners, LP||(NYSE:SEP)||50.63||0.5563||4.40||83.65||83.97||11.64||14.10||5.08||14.94||3.10||10.97||-1.54|
|Sunoco Logistics Partners L.P.||(NYSE:SXL)||91.70||0.6950||3.03||63.33||59.66||21.49||23.33||-4.67||28.16||-4.77||21.40||1.12|
|TC PipeLines, LP||(NYSE:TCP)||48.74||0.8100||6.65||85.26||83.08||0.64||3.99||14.59||4.08||2.70||3.85||-10.00|
|Tesoro Logistics LP||(NYSE:TLLP)||69.15||0.5900||3.41||85.51||71.52||32.12||34.37||5.49||18.37||-10.10||20.41||5.88|
|Transmontaigne Partners L.P.||(NYSE:TLP)||45.40||0.6600||5.81||70.59||77.65||6.82||9.93||-5.86||0.52||6.86||3.13||-6.67|
|Western Gas Partners LP||(NYSE:WES)||73.42||0.6250||3.41||79.37||69.44||19.01||21.04||0.87||8.70||3.28||15.74||0.00|
|Williams Partners L.P.||(NYSE:WPZ)||52.63||0.9045||6.87||97.00||90.45||3.48||7.04||-10.28||6.79||4.48||6.73||-1.85|
|EnLink Midstream Partners, LP||(NYSE:ENLK)||30.24||0.3600||4.76||95.36||77.42||9.57||12.17||2.17||16.88||-3.82||9.09||2.35|
|Navios Maritime Partners L.P.||(NYSE:NMM)||18.85||0.4425||9.39||111.32||97.25||-1.41||3.22||-4.11||8.48||-9.14||0.00||0.00|
|Martin Midstream Partners LP||(NASDAQ:MMLP)||40.82||0.7875||7.72||95.45||82.03||-4.63||-0.95||-1.25||-1.49||-5.17||1.61||6.06|
|Teekay LNG Partners LP.||(NYSE:TGP)||43.76||0.6918||6.32||93.49||90.14||2.46||5.70||12.62||1.17||0.34||2.49||0.00|
|The (price change only) Alerian MLP index [the ^AMZ - which includes other MLP sectors] is 9.44% year to date.|
|The Alerian MLP index ETN AMJ is 9.17% and with dividends is 11.64%.|
|The S&P500 index ETF SPY is 6.09% and with dividends is 7.05%.|
|The Russell 2000 index ETF IWM is 2.51% and with dividend is 2.77%.|
|With the 10yr Treasury @ 2.61% & the sector average yield [on Q2 distrib's] at 5.4% - the spread is 279 bps.|
|With the JNK yielding 5.63% - spread to the Lehman U.S. High Yield Index is -24 bps.|
|With the HYG yielding 5.44% - the spread to the iBOXX High Yield Index is -5 bps.|
Show me your accuracy ratings
I have assigned an accuracy rating to each MLP - and this is my key metric used in setting RRRs. A '1' (or best) to '5' (worst) rating is given to each MLP based on the accuracy - or lack of unpleasant surprises - of the DCF estimates. The scoring system is informal. To be a '1' - the MLP will have estimate changes less than 10% over several years - and if there are changes, then they are upgrades. I never count a large upgrade against an MLP is setting the accuracy rating. A '5' will have many changes over 10% - and those changes also strongly tend to be down grades. The rating is also time sensitive - with surprises in recent years counting more heavily than long ago surprised. The rating is also direction sensitive - with downgrades having more influence than upgrades.
My working theory - which has been confirmed by time - is that some assets produce income flows that are more predictable - while other assets produce income flows that are less predictable. This attribute shows up in this spreadsheet. And MLPs with more predictable cash flows should logically have lower required rates of return. In other words, their yields should logically be lower, and their price to DCF ratios should also be higher due to this attribute. Forward same year DCF estimate spreads [which is provided in another spreadsheet], credit ratings, debt metrics, and the Dividend Discount Model derived 'price implied RRR' will also be used as tools in assigning RRRs.
Changes in DCF estimates by Year: Some MLPs Have Assets That Produce More Predictable DCFs
Why isn't there a 100% correlation between your risk assessments and your RRRs?
Accuracy rating are the key component is assessing RRRs, but they are not the only component. I use bond ratings, the high/low projection spreads, debt to market caps, debt to EBITDAs, and brokerage analyst RRR assessments to arrive at a final RRR. I have already shown a boat load of numbers - and there are more numbers still to come. To some degree I am protecting you from information overload by not going "Full Monty" in disclosing everything. There are also legal impediments to sharing some of the data that I receive from brokerage reports.
What are the numbers for those who had falling DCF projections? Did accuracy ratings matter?
Intra-year DCF Estimate Increases and Year to Date Returns:
The following companies had 2014 DCF estimate increases since the beginning of 2014: ACMP, EPB, EPD, EQM, EXLP, HEP, MMP, NGLS, NS, OILT, SEP, TCP, TLP, WES and WPZ. Their mean price gain for the year is 17.07%. Their mean total return for the year is 19.83% - and 8 of the 15 beat the sector median yearly price gain [9.98%]. Their average historical DCF projection accuracy rating is 1.49.
The following companies had 2014 DCF estimate decreases since the beginning of the year: AMID, APL, BKEP, BPL, BWP, CMLP, DPM, EEP, ETP, GEL, KMP, MWE, PAA, RGP, SXL, TLLP and ENLK. Their mean price gain for the year is 5.86%. Their mean total return for the year is 8.69% - and 7 of the 17 beat the sector median yearly price gain. Their average accuracy rating is 2.92.
Prove to me falling DCF projections and accuracy ratings matter year after year
In 2013: Intra-year DCF Estimate Increases and Full Year Returns:
The following companies had 2013 DCF estimate increases since the beginning of 2013: ACMP, EPD, ETP, EXLP, MMP, OILT, PAA and SXL. Their mean price gain for the year is 45.03%. Their mean total return for the year is 51.40% - and 6 of the 8 beat the sector median yearly price gain [32.47%]. Their average historical DCF projection accuracy rating is 1.61.
The following companies had 2013 DCF estimate decreases since the beginning of the year: AMID, APL, BKEP, BPL, BWP, CMLP, DPM, EPB, EEP, EQM, GEL, HEP, KMP, MWE, NGLS, NS, OKS, RGP, SEP, TCP, TLLP, TLP, WES, WPZ and XTEX. Their mean price gain for the year is 28.09%. Their mean total return for the year is 35.55% - and 7 of the 25 beat the sector median yearly price gain. Their average accuracy rating is 2.58.
The following companies - editing out AMID and XTEX which had GP related valuation changes - had 2013 DCF estimate decreases since the beginning of the year: APL, BKEP, BPL, BWP, CMLP, DPM, EPB, EEP, EQM, GEL, HEP, KMP, MWE, NGLS, NS, OKS, RGP, SEP, TCP, TLLP, TLP, WES and WPZ. Their mean price gain for the year is 22.35%. Their mean total return for the year is 29.49% - and 5 of the 23 beat the sector median yearly price gain. Their average accuracy rating is 2.41.
In 2012: Intra-year DCF Estimate Increases and Full Year Returns:
The following companies had 2012 DCF estimate increases since the beginning of 2012: ACMP, EPD, GEL, HEP, KMP, MMP, NGLS, OKS, PAA, SXL, TLP and WES. Their mean price gain for the year is 13.69%. Their mean total return for the year is 19.71% - and 10 of the 12 beat the sector median yearly price gain [-2.62%]. Their average historical DCF projection accuracy rating is 1.33.
The following companies had 2012 DCF estimate decreases since the beginning of the year: APL, BPL, BWP, CMLP, CPNO, DPM, EPB, EEP, ETP, EROC, EXLP, MWE, NS, RGP, SEP, TCP, WPZ and XTEX. Their mean price gain for the year is -13.22%. Their mean total return for the year is -6.27% - and 3 of the 18 beat the sector median yearly price gain. Their average historical DCF projection accuracy rating is 2.50.
In 2011 (the first year I attempted accuracy ratings): Intra-year DCF Estimate Increases and Full Year Returns:
The following companies had 2011 DCF estimate increases since the beginning of 2011: APL, CHKM, CMLP, EPB, EPD, EROC, EXLP, KMP, MMP, MWE, NGLS, OKS, PAA, SXL, TLP, WES, WPZ and XTEX. Their mean price gain for the year is 19.07%. Their mean total return for the year is 25.77% - and 14 of the 18 beat the sector median yearly price gain [8.32%]. Their average historical DCF projection accuracy rating is 2.39.
The following companies had 2011 DCF estimate decreases since the beginning of the year: BPL, BWP, CPNO, DPM, EEP, ETP, GEL, HEP, NS, RGP, SEP and TCLP. Their mean price gain for the year is -1.59%. Their mean total return for the year is 4.93% - and 1 of the 12 beat the sector median yearly price gain. Their average historical DCF projection accuracy rating is 2.75.
For 2011 there were a lot of commodity sensitive MLPs having DCF projection increases. Being commodity sensitive is not always a bad thing.
Prove to me I can purchase lower risk MLPs without paying too high of a premium
The relationship between credit ratings and yields: Marine transportation MLPs are weeded out as is the distribution cutting BWP.
The following companies had corporate credit ratings of BBB+ or BBB: EPB, EEP, EPD, KMP, MMP, OKS, PAA and WPZ. Their current average yield is 5.51%. Their average CAGR is 5.42%.
The following companies had corporate credit ratings of BBB-: BPL, DPM, ETP, SXL, TCP and WES. Their current average yield is 5.08%. Their average CAGR is 6.10%.
The following companies had corporate credit ratings of BB+, BB or BB-: ACMP, CMLP, GEL, HEP, MWE, NGLS, NS, RGP, SEP and TLLP. Their current average yield is 5.22%. Their average CAGR is 6.72%.
The following companies had corporate credit ratings of B, B+, B- or were note rated: APL and EXLP. Their current average yield is 7.46%. Their average CAGR is 5.15%.
Give me an example of where I may not be thinking about risk in the right way?
I will use the Socratic Method and ask you if Enterprise Products Partners is having a great year for their investors. Its total return or price appreciation and its distribution has been 15.88% compared to the sector average of around 12%. That could appear to you to be just about average. But EPD is a low risk option. EPD unit holders received that slightly better than average return while facing significantly lower risk. Given the lower risk context, the total return is very good.
All you have proven is that your hindsight in 20-20. Prove to me that you can accurately forecast something.
Let's look at my only published list of MLP suggestions done on 9-23-13 and see how they have done in 2014. That message can be found at Redefining Value Investing for MLPs.
That list of suggestions was: Plains All American Pipeline (which is up in price 12.15% and counting the distribution is up 14.58%); Magellan Midstream Partners (up 29.76% and 31.70%); Sunoco Logistics Partners (up 21.49% and 23.33%); Kinder Morgan Energy Partners (down 0.51% and up 2.91%); Access Midstream Partners (8.01% and 10.04%); Western Gas Partners (19.01% and 21.04%); Spectra Energy Partners (up 11.64% and 14.10%); Targa Resources (up 56.62% and 58.00%); Atlas Energy (down 6.28% and 4.31%); and Williams Companies (up 49.49% and 50.54%). The ^AMZ is up 9.44% and the ETN AMJ is up 9.17% and 11.64%. Seven of the ten beat the sector average - which is a decent percentage of beats. The average for the whole portfolio of suggestions is up 20.14% and 22.19%. That is roughly double the return of the index. I would not give myself an A for this effort. There was some luck involved with the inclusion of both TRGP and WMB. I missed the call on EQM and OILT. My failure to have Phillips 66 Partners (NYSE:PSXP) and Emerge Energy Services (NYSE:EMES) in my coverage universe is a notable fault. And I should not have included the high risk ATLS in my suggestions. I think the list was worthy of a B+ grade.
Why is Kinder Morgan Energy Partners - which was one of your suggestions - having an off year?
KMP provided 2014 distribution growth guidance in its conference call on fourth quarter earnings that was well below trend and below expectations. The price for KMP had to adjust to a lower CAGR projection along with a downward adjustment caused by the uncertainty it introduced due to offering guidance that was so unexpected.
At this point, I have run out of legit questions that a doubter might ask. I am sure I missed some. I hope you let me know in the comment section. I also hope you are not needing a summary. There is not a single piece of data I would want to omit in an attempt to shorten or sum things up. But if you have to have one - this would be it: Risk - some folks get it and some folks don't. I hope this article nudged you closer to the first group.
Disclosure: The author is long CMLP, DPM, EPD, GEL, KMP, MMP, MWE, TRGP, WES, WMB. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.