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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.

Source: An Alternative Method To Rank Pipeline MLPs