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Summary

  • Upstream MLPs are a seldom researched segment of the market.
  • These stocks generally trade inline with each other in terms of yield and valuation.
  • However, a few gems can be found.

The upstream MLP sector has had more than its fair share of volatility over the past year or so. This was mostly a result of short-seller pressure and negative press from the likes of Barron's and others.

Fortunately, there seems to have been a recovery. Linn Energy (NASDAQ:LINE) and LinnCo (NASDAQ:LNCO), by far the largest of the group, have both surged ahead and are now firmly above $30 per unit/share. Meanwhile, one of the weaker, and as a result cheaper, stocks in the sector QR Energy (NYSE:QRE) is being merged/bought by BreitBurn Energy Partners (NASDAQ:BBEP), creating arguably a much stronger combined company.

The focus of this article is to analyze the upstream MLP sector as a whole, looking at metrics such as valuation, distribution yield, and coverage ratios.

How do the various upstream MLPs compare?

For my analysis I will be comparing the upstream MLPs listed below:

  • Linn Energy
  • BreitBurn Energy Partners
  • QR Energy
  • Vanguard Natural Resources (VNR)
  • EV Energy Partners (EVEP)
  • Atlas Resource Partners (ARP)
  • Legacy Reserves (LGCY)
  • Memorial Production Partners (MEMP)
  • LRR Energy (LRE)
  • Mid-Con Energy Partners (MCEP)
  • New Source Energy Partners (NSLP)

Furthermore, I will be using the latest Q2 2014 distributable cash flow, or DCF, figures for these stocks. Do note that this is a non-GAAP metric and varies somewhat from company to company. My data is mostly provided by MLPdata.com, Google Finance, and company filings.

Valuation

For starters, let us look at valuation. I have found that a good way to compare the various upstream MLPs is via the their price to TTM DCF ratio, or simply P/DCF. Below are the stocks ranked from lowest multiple to highest.

  • ARP: 8.49x
  • LRE: 9.32x
  • LINE: 9.86x
  • MCEP: 10.00x
  • QRE: 10.37x
  • BBEP: 10.44x
  • MEMP: 11.34x
  • NSLP: 12.03x
  • LGCY: 12.66x
  • VNR: 12.95x
  • EVEP: 18.16x

Leading the pack in terms of value is ARP with a rock bottom valuation of 8.49x. This may be a result of some short-seller pressure with the stock down over 10% since April. LRE also appears to be cheap, trading at a modest 9.32x multiple. These two are also among the minority in that they both have GPs to deal with and hence pay out IDRs. This may explain some of the discount to peers.

Both LGCY and VNR appear to trade at premium to peers with multiples of over 12x. In the case of EVEP, its massive 18x multiple may be somewhat justified given that it does have a sizable midstream segment.

Besides these few outliers, it seems as if the entire upstream MLP sector trades within a narrow 200 basis point range, from 10x to 12x. Quite remarkable.

Distribution yield

Next, we will look at these stocks by their current yields. The list will go from highest yielding to lowest:

  • ARP: 11.92%
  • LRE: 10.61%
  • LINE: 9.40%
  • MEMP: 9.39%
  • QRE: 9.36%
  • MCEP: 9.26%
  • BBEP: 9.08%
  • NSLP: 8.89%
  • VNR: 8.44%
  • LGCY: 8.09%
  • EVEP: 7.65%

Not surprisingly, this list is eerily similar to the valuation list. The reason for this is that upstream MLPs typically pay out nearly 100% of DCF with a few exceptions. Hence the yields are often an inverse reflection of the multiples.

In terms of outliers, ARP offers significant income at nearly 12%, 130 basis points above the next closest LRE at 10.60%. Meanwhile, LGCY and EVEP yield well below their peers, likely a result of their elevated stock prices.

Once again, besides the outliers, the sector as a whole seems to yield between 8.40% and 9.40%, a tiny 100 basis point range.

Coverage Ratio

Lastly, let us look at the upstream MLPs by their coverage ratios. This metric is often very volatile Q/Q. Therefore, it is best to use the TTM DCF divided by the TTM distributions for comparison purposes.

  • LINE: 1.08x
  • MCEP: 1.08x
  • LGCY: 1.07x
  • BBEP: 1.06x
  • QRE: 1.05x
  • ARP: 1.01x
  • LRE: 1.01x
  • NSLP: 0.95x
  • MEMP: 0.94x
  • VNR: 0.92x
  • EVEP: 0.72x

As I noted above, most upstream MLPs pay out close to 100% of DCF. As a result, the fact that many are near 1.00x coverage ratios is hardly surprising.

LINE, thanks to its flurry of asset swaps, has a very robust coverage ratio. It along with MCEP may be due for a distribution boost in the short to medium term.

Conclusion

As there seems to be a dearth of coverage on many of these names, this sort of analysis can often lead to the discovery of true gems. In this example, it appears ARP is being grossly mispriced by the market. I plan to do further research on this name. Meanwhile, LINE and LRE appear to be undervalued, but not by as much as ARP.

On the other end of the spectrum, EVEP is a pricey stock. At the same time, its distribution appears to be on shaky ground. A TTM coverage ratio of 0.72x is abysmal, no matter how you spin it.

Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.