Seeking Alpha
What is your profession? ×
Research analyst, dividend investing, oil & gas, master limited partnerships
Profile| Send Message|
( followers)


Bottom fishing in the MLP space can deliver differentiated returns. We prefer beaten-down names with a credible plan to restore the MLP's growth prospects.

EEP has spun off its under-performing gas-related assets as MEP, providing a reliable source of low-cost capital to fund growth projects. ENB's restructuring of EEP's IDR also provides breathing room.

ENB has also reiterated commitment to dropping down assets to EEP once the MLP's cost of capital improves; expect ENB to continue to pursue policies that drive EEP yield compression.

NS management has divested underperforming assets and established impressive growth platform in Eagle Ford Shale. In Q2, NS covered distro for first time in almost 3 years.

NSH offers leveraged exposure to NS' turnaround story.

In 2009 and 2010, master limited partnerships (MLP) that suffered the most when commodity prices collapsed rallied hard from the huge losses posted in the previous years.

Atlas Pipeline Partners LP and Eagle Rock Energy Partners LP (NSDQ: EROC), both of which slashed their distributions because of financing constraints and/or their sensitivity to energy prices, didn't enjoy a recovery rally until they restored their payouts in 2011.

Although the 2009-10 recovery rally stands out as a unique period in recent market history, one lesson bears repeating: Investors shouldn't offhandedly dismiss beaten-down names that operate out-of-favor business lines.

For example, Niska Gas Storage Partners LLC (NYSE: NKA) emerged as one of the top-performing MLPs in 2012 after losing almost half its value in 2011.

Surging hydrocarbon production from prolific shale plays has reduced the seasonal spread between natural-gas prices in the winter and summer-a key driver of storage demand.

In this environment, Niska Gas Storage Partners faced a cash flow crunch because expiring storage contracts renewed at dramatically lower rates. Speculation that the MLP would slash its distribution ran rampant.

But Niska Gas Storage Partners' general partner suspended its subordinated distribution indefinitely in the second quarter of 2012, ensuring the partnership would maintain the payout disbursed to common unitholders-a short-term upside catalyst for the beaten-down stock.

Likewise, Capital Product Partners LP (NSDQ: CPLP) delivered a 76.7 percent return in 2013, thanks to a supportive general partner that helped the partnership to maintain its distribution by engaging its product tankers and other vessels at above-market rates during a period of general weakness.

Bottom fishing enables intrepid investors to lock in huge yields but also entails significant risk if no upside catalyst emerges. If Niska Gas Storage Partners and Capital Product Partners' general partners hadn't offered a helping hand, these names wouldn't have outperformed and likely would have cut their distributions.

Consider some of the worst-performing MLPs from recent years: cash flow-constrained names that ultimately opted to slash their distributions to shore up their balance sheets and wait for industry conditions to improve.

Earlier this year, Boardwalk Pipeline Partners LP (NYSE: BWP) slashed its distribution by more than 80 percent after expiring contracts on its long-haul gas pipelines severely crunched the MLP's cash flow.

Eagle Rock Energy Partners and Natural Resources Partners LP (NYSE: NRP) likewise slashed their payouts in 2014, reducing unitholders' income streams and saddling them with outsized capital losses.

With an eye toward value and capital preservation, we prefer to focus on potential turnaround stories where distribution growth has slowed or stalled, but the payout doesn't appear to be under threat.

At the same time, management must have a credible plan to restore the MLP's fortunes and exceed the market's low expectations. Here's our latest take on two of our favorite turnaround stories; both names have rewarded our faith with big returns since we added these stocks to Energy & Income Advisor's model MLP Portfolios.

Enbridge Energy Partners LP (NYSE: EEP)

Our initial bet on Enbridge Energy Partners was based on the market's failure to appreciate the various levers that this struggling MLP could pull to unlock value for unitholders.

Enbridge Energy Partners has made several moves on this front, monetizing its underperforming gas-related assets with the initial public offering of Midcoast Energy Partners LP (NYSE: MEP). This move creates an ideal vehicle for Enbridge Energy Partners to raise low-cost capital to fund its own growth projects while removing a liability from its balance sheet.

At the same time, the MLP's general partner, Enbridge (NYSE:ENB) restructured its incentive distribution rights (IDR) to give the MLP more breathing room and setting the stage for this quarter's distribution increase and potential drop-down transactions from its sponsor. (See Enbridge Energy Partners LP Gets a Little Help from Its Friend.)

These moves contributed to Enbridge Energy Partners' solid second-quarter results, headlined by a 2.1 percent increase to the MLP's quarterly payout-the first hike since July 2012 and an indication of the progress that the partnership has made in its restructuring effort.

Although the MLP generated enough distributable cash flow to cover 104 percent of its cash distribution, this coverage ratio shrinks to 87 percent if you treat the general partner's paid-in-kind distributions as cash. We expect this ratio to improve as Enbridge Energy Partners brings expansion projects onstream and completes drop-down transactions from its sponsor.

In the second quarter, Enbridge Energy Partners raised additional capital to support these endeavors by dropping down an additional 12.9 percent interest in its gas-related infrastructure to Midcoast Energy Partners for $350 million in cash. Management expects to complete the sale of these assets by 2017.

Not only does Midcoast Energy Partners give Enbridge Energy Partners a vehicle to monetize its gas-related assets and raise low-cost capital, but also the MLP could eventually transfer its general-partner interest to its parent, Enbridge, in exchange for retiring some of its common units or MLP-qualifying assets.

Energy Transfer Partners LP (NYSE: ETP) and Energy Transfer Equity LP (NYSE: ETE) have used these kick-up transactions to great effect, with the former transferring its general-partner interest in Sunoco Logistics Partners LP (NYSE: SXL) and LNG-related assets in Lake Charles in exchange for the parent retiring some of its common units. These innovative kick-up transactions have helped to drive Energy Transfer Partners' recent run of distribution growth. (Two years ago and 56 percent ago, we highlighted Energy Transfer Partners as a value play.)

Enbridge Energy Partners can also raise capital by gradually disposing of its equity interest in Midcoast Energy Partners.

From an operational perspective, an increase in rates and record-setting throughput on its Lakehead and North Dakota liquids pipeline systems were the big stories from the second quarter.

The MLP also started commercial operations on a big portion of its Eastern Access pipeline system, which also contributed to volume and revenue growth.

All told, deliveries on Enbridge Energy Partners liquids systems increased by 29 percent from year-ago levels.

This momentum should continue into the back half of 2014. Management expects volumes on the Lakehead system to ramp up, while a 160,000 barrels per day expansion to the MLP's Mainline pipeline system comes onstream in the third quarter and the remaining 50 miles of pipe on its Line 6B pipeline replacement project will start commercial operations in the fourth quarter.

We also expect throughput on the MLP's pipelines serving the Bakken Shale to benefit from tightening regulations on shipping crude by rail.

Enbridge Energy Partners will also complete a number of expansion projects in 2015 that should more than offset any cash flow lost from dropping down its gas-related assets to Midcoast Energy Partners.

That being said, Enbridge Energy Partners plans significant capital expenditures for 2015, suggesting that the MLP's distribution coverage ratio will fluctuate around 100 percent before increasing in 2016.

With each quarter, we grow increasingly confident in Enbridge Energy Partners LP's turnaround story, especially with Enbridge promising to drop down assets once the MLP's cost of capital improves.

NuStar GP Holdings LLC (NYSE: NSH)

After an extended period of weakness and some dubious investment decisions by its former management team, NuStar Energy LP (NYSE: NS) posted second-quarter results that increased our confidence in the MLP's turnaround story.

The ailing partnership generated enough distributable cash flow to cover its payout by 110 percent-the first reporting period without a shortfall in almost three years. Much of this improvement came from the pipeline segment, where throughput increased 17 percent from year-ago levels.

As part of its strategic shift, NuStar Energy has divested its interest in cyclical businesses in favor of organic expansion projects at its South Texas pipeline system, which supports customers in the prolific Eagle Ford Shale.

This turnaround effort involved the divestment of the MLP's ownership interest in the San Antonio refinery and its exit from the much-maligned asphalt business.

In late 2012, NuStar Energy accelerated its growth opportunities in the Eagle Ford Shale with the $325 million acquisition of crude-oil and NGL pipelines and related storage and gathering assets from privately held TexStar Midstream Services LP.

The MLP in the second quarter completed the first expansion to its South Texas pipeline system, bringing the capacity to 135,000 barrels per day. Management expects to complete the second phase, which will increase the capacity to 200,000 barrels per day, in the second quarter of 2015.

NuStar Energy also more than tripled the capacity of its docks in Corpus Christi, enabling customers to move crude-oil volumes across the Gulf of Mexico to refineries in Louisiana.

This valuable asset also puts the company in pole position to take advantage of potential condensate exports. (See Condensate Conundrum.) In fact, management noted that the firm has started to work on modifications to its pipeline that would segregate minimally processed condensate from other volumes.

We also like the MLP's agreement with Occidental Petroleum to reactivate and reverse an idled pipeline that will transport NGLs to the oil and gas company's propane export facility in Ingleside, Texas. NuStar Energy expects this project to come onstream in the second quarter of 2015.

Management indicated that it would continue to focus on organic growth opportunities afforded by its existing asset base while eyeing complementary acquisitions in the Eagle Ford Shale. Constructing or acquiring oil-gathering lines to supply its South Texas pipeline network would be one option.

The Niobrara Shale in the Rockies is a basin that the MLP would consider entering. In 2012, NuStar Energy held an open season for its Niobrara Falls project, which consisted of a new crude-oil pipeline that would run from the Colorado to the MLP's existing refined-products pipeline that runs from McKee, Texas, to Denver. The project contemplated reversing and converting the latter pipeline to crude-oil service.

A lack of shipper interest scotched the project two years ago, but rapidly growing production in the Niobrara Shale could make this pipeline more viable.

Management has also considered adding rail capabilities at its crude-oil terminals in Vancouver and eastern Canada.

But the progress in NuStar Energy's pipeline segment must overcome near-term weakness in its terminal segment, where a crude-oil market in contango-spot prices are lower than volumes for future delivery-has weighed on demand from traders.

In particular, management highlighted weakness at its West Coast facilities and reduced profit sharing at its terminals in St. James, La., because of the tightening spread between Light Louisiana Sweet crude oil and West Texas Intermediate.

Management's forecast calls for its storage segment to generate flat adjusted operating earnings relative to year-ago levels. Thus far, the MLP hasn't encountered problems renewing expiring storage contracts, though rate increases have been harder to come by.

NuStar GP Holdings LLC, which owns a 2 percent general partner interest in NuStar Energy and 12.9 percent of the MLP's outstanding common units, sports a distribution yield of about 6 percent-easily the highest among pure-play general partners.

Buying the general partner gives us exposure to NuStar Energy's turnaround story-and any premium in a potential takeover.

Plains All American Pipeline LP (NYSE: PAA) is on the hunt for an acquisition after its general partner, Plains GP Holdings LLC (NYSE: PAGP), went public.

At the same time, an activist investor used NuStar Energy's third-quarter earnings call last year to press for a combination with Kinder Morgan Inc. (NYSE: KMI) or one of the other large MLPs.

And even if a takeover offer never materializes, NuStar Energy is eyeing about $1 billion worth of expansion projects and appears to have turned the corner. NuStar GP Holdings has rallied considerably as its distribution coverage has improved, but we see more upside ahead for this turnaround play.

Check out my free video explaining the advantages of investing in MLP IPOs and highlighting one of our favorites from this year.