MLPs are probably among the best investment vehicles for the income-oriented investors. They offer substantial distributions to the unit holders. Given the low-interest environment, their distribution rates are much better than the paltry interests offered by government bonds.
The distributions also help MLPs by sheltering their profits from corporate profit taxes. The distributions are deducted from their taxable income as a "depreciation expense". As far as I know, MLP distributions are exempt from corporate taxes to the extent that the deprecation expenses cover their income.
MLP Valuations
Recently, I published an article on Kinder Morgan Partnership (KMP), suggesting that the stock is in the overbought territory. Yield hungry investors have driven many MLPs to overbought levels. While I think these partnerships offer substantial income in a solid business, it is not the right time to invest in MLPs right now. Apparently, most readers agree with me. One reader commented "KMP is still an excellent company but approximately 15% overvalued at this point due to market hype of MLP's". One reader asked a seriously hard question:
What is the fair value for an MLP?
Suggesting a fair value for a partnership is a great challenge. It is not easy to evaluate an MLP since they have a lot of assets, which are subject to significant depreciation charges. The depreciation expenses reduce their earnings on the balance sheet, with no real effect on the cash flow generated by the company.
In the world of MLPs, cash flow is the best valuation criteria for the distribution safety. However, even the cash flow is a bit complicated. Many MLPs issue additional units and raise capital through debt. As a result, their operating and free flows could differ significantly.
In addition to their assets, they also have significant debts. It is highly possible that the source of distributions could be debt financing. Therefore, even the Price to Free Cash Flow ratio is not a good measure to rank MLPs. Therefore, it remains as a master challenge to rank these companies based on an objective criteria.
Pipeline MLPs
Most MLPs operate in the energy sector as pipeline operators. These companies have pretty stable sources of revenues and solid profit margins. While the underlying commodity prices could be highly volatile, most pipeline operators are in a pretty stable business. Since they charge fees based on the volume of the product being transported, their future revenues and cash flows are fairly predictable.
Market Cap Per Employee
Let's assume that pipeline companies have access to the same technology, where the productivity per person is equal. Note that this is not a strong assumption, as all of these companies operate in the same industry, with stable operating cash flow. A larger company is naturally expected to employ more workers. The following graph shows that there is a remarkably strong relationship between the number of workers employed by the company and the company's market cap.
Y = Market Cap = 2.89 * Number of Employees + 1297.
There is almost perfect correlation between the two variables.
Click to enlarge:
As can be shown from the graph above, a simple regression between the company's market cap and the number of employees explain almost 84% of variation in the market capitalization data. The graph above also shows the companies that are priced with a premium market cap per employee. The companies above the linear trend line are priced with a premium, whereas the companies below the trend line are priced with a relative discount. The following table makes it clear to see the rank of each company based on its market cap per employee.
Company | Ticker | Employees | Market Cap ($ million) | Market Cap / Employee ($ million) | Market Cap Per Employee |
Buckeye Partners | (BPL) | 859 | 5850 | 6.81 | High |
Boardwalk Pipeline | (BWP) | 1100 | 5710 | 5.19 | Normal |
Copano Energy | (CPNO) | 357 | 2600 | 7.28 | Very High |
DCP Midstream | (DPM) | 304 | 2080 | 6.84 | High |
Enbridge | (ENB) | 6357 | 30290 | 4.76 | Normal |
El Paso | (EP) | 4937 | 21860 | 4.43 | Normal |
Energy Transfer Equity | (ETE) | 6229 | 9530 | 1.53 | Very Low |
Energy Transfer Partners | (ETP) | 5433 | 11020 | 2.03 | Low |
Genesis Energy | (GEL) | 690 | 2220 | 3.22 | Low |
Holly Energy | (HEP) | 148 | 1340 | 9.05 | Very High |
Kinder Morgan, Inc. | (KMI) | 8142 | 25650 | 3.15 | Low |
Kinder Morgan Energy Partners | 8120 | 29790 | 3.67 | Normal | |
Magellan Midstream | (MMP) | 1271 | 8140 | 6.40 | High |
Targa Resources | (NGLS) | 1020 | 3850 | 3.77 | Normal |
Nustar Energy | (NS) | 1413 | 4350 | 3.08 | Low |
Nustar GP Holdings | (NSH) | 1413 | 1450 | 1.03 | Very Low |
Oiltaking Partners | (OILT) | 154 | 1240 | 8.05 | Very High |
ONEOK | (OKS) | 4795 | 11880 | 2.48 | Low |
Plains All American | (PAA) | 3500 | 12910 | 3.69 | Normal |
Regency Energy | (RGP) | 793 | 4070 | 5.13 | Normal |
Spectra Energy | (SE) | 5500 | 20470 | 3.72 | Normal |
SemGroup | (SEMG) | 800 | 1190 | 1.49 | Very Low |
Sunoco Logistics | (SXL) | 1400 | 4040 | 2.89 | Low |
Williams Companies | (WMB) | 5022 | 17840 | 3.55 | Normal |
WIlliams Partners | (WPZ) | 3176 | 18500 | 5.82 | High |
Average | 2917 | 10315 | 4.36 |
While I tried to include all pipeline operators, regardless of their market cap, the information on the number of employees did not exist for several companies. After adjusting for the missing observations, we have 25 companies in the data. Using this sample set, we can state that an average pipeline operator employees around 2900 workers with a market cap of $10 billion. The average market cap per employee is calculated as 4.36.
Summary
The pipeline business is a very stable one. Most operators have either monopoly or oligopoly status in their region of operation. Therefore, the assumption of similar productivity per worker is a reasonable assumption. Given the efficient market hypothesis, similar worker productivity should translate into similar market caps per worker. The model above also suggests a strong correlation between the number of workers and market cap. While most companies in this field have similar ratios, there are some deviations. This is pretty natural as a stock's market performance might deviate from the underlying company.
Copano Energy, Holly Energy, Oiltaking Partners are trading at a premium (per worker) market caps. There might be two explanations for this observation. First, it might be the case that these companies are significantly overvalued compared to their peers. Next, it could be the case that they utilize their employees more efficiently than others.
Based on the market cap per employee criteria, Energy Transfer Equity, Nustar GP Holdings, and SemGroup trade at significant discounts compared to other pipeline operator MLPs.
Note that market cap per employee is a simple criteria, which does not necessarily suggest that these stocks are cheaper compared to their peers. It might be the case that they employ more employees than what they need. Nevertheless, it could be an interesting tool to add to your knowledge.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
