Why MLPs Need a Correction Before Continuing Their Climb Upward

Includes: AMJ, EEP, ENB
by: Avi Morris

MLPs are having an extraordinary 2 years which few industry groups have been able to match. Below is a condensed history of the Alerian MLP Index in recent years including year-end figures and a few memorable dates.

In 8 years the index has more than grown at a compounded annual growth rate over 12% and the comparable index including reinvested income has grown at rate of 19%, some of the best rates at a time when many stocks, including Dividend Aristocrats, have made little or no progress.

Also included is the previous record peak in 2007 when the yield for the index reached a record low of 5.37% which roughly matched the yield on the 10-year Treasury bond near 5¼%. On the 2 year anniversary of the index low during the recession, it has more than doubled and the index with reinvested income is approaching triple.

Alerian MLP Index

Date_________Index___With Income


The business model for MLPs did not materially change in recent years. MLPs raised equity selling units to back up increased borrowings used to finance more miles of pipelines. In the difficult times 2 years ago, MLPs were able to arrange financing.

For example, Enbridge Energy (NYSE:EEP) received an increase in equity when general partner, Enbridge (NYSE:ENB), the large Canadian energy company, purchased additional units at what turned out to be an opportune time. The markets have improved dramatically. This week EEP sold 6 million units (including over-allotments) at $60.12 per unit in a public offering generating net proceeds of $347 million. Many businesses complain that they can not borrow, but not MLPs.

MLPs are having their 2nd straight impressive year, up 25% YTD after a 62% advance last year. The bull market this year resulted from (1) a rising stock market, (2) new closed end funds were started to invest in MLPs and (3) a drop of yields on Treasuries to or near record low levels and investors were willing to accept lower MLP yields.

The stock market may be topping out, although bulls are calling for further gains. Additional new closed end funds for MLPs are not being started. But the direction of interest rates is the most difficult to call after the recent decline in Treasury prices which caused interest rates to soar (50 basis points on the 10-year Treasury).

I see more headwinds than following winds going into 2011. MLPs will have a very difficult time coming up with an encore after the index has doubled (income aside) in 2 years bringing some of the lowest yields (6.3%) on the index. A pullback would clear out weaker holders who are not serious and help set the stage for the next major advance.

Disclosure: No poisitions