MLPs: Still Alive and (Reasonably) Well

I hadn't intended to follow up so quickly on my MLP article from last week, but these are extraordinary times. MLPs have been through a brutal and wild five years - only this all happened in the last couple of weeks.

MLPs are utility type of securities because of their high yields, but have been hammered badly in the recent sell-off. It took the Alerian MLP Index almost 12 years to rise from 100 to 342. Then the index dropped 80 after reaching the peak last year (following the weak markets). In just the last couple of weeks, it dropped another 100. Even the most loyal fans of MLPs have been asking "What's going on?"

Their high yields have gone through the roof with after the recent sell-off, well into double digits. Typically yields have been around 6-7%. One key measured used is the yield should be 200 basis points above the T-bond rate. At the low last week, that spread skyrocketed to 1000 basis points, a level nobody could have imagined just one month ago.

MLPs remain utility kind of investments, featuring high yields. Their distributions continue to be largely tax free in the year when paid. Ownerships is measured by owning units bringing a fair amount of tax hassle from their K-1 tax reports, but many accept this because of the high yield & utility type, reliable yield.

In the middle weeks of October, they set the distributions for Q4. Last week, Kinder Morgan (KMP), the largest MLP, announced a 3¢ increase, for Q4, above the 99¢ rate in Q3. Others also announced increases last week. Increases should continue, these firms have an incentive to help attract more friends in a very ugly market.

Their business are intact. MLPs generally own pipelines and terminals for moving oil and gas around the country. They own hard assets (like REITs which own buildings and real estate), making it relatively easy to obtain financing.

The enormous rally on Monday follows plenty of mass selling which helped correct vastly oversold positions. Given the unprecedented wild market swings (the VIX reached record levels above 70), daily trading will probably continue to be unusually volatile. But the long term for MLPs remains attractive. Building more pipelines to move oil and gas is a national priority, the reason the government gives tax incentives for investment.

For an investor whose investment goals are long term, the extremely high yields along with capital appreciation should prove to be an attractive investment. Unusually low security prices provide additional incentives.

Disclosure: No positions

Comments

[Augustus:]

An investigation of BSR would be interesting to read. An ETF of the Alerian index. Besides the diversification the different MLPs, it avoids that multi state taxation headache. Possibly worth the fee for management.

2008 Oct 15 10:54 AM

[Mitch Tuchman:]

Avi -- I've read your MLP articles with great interest and they've helped inform my thinking quite a bit. You seem to really understand the area. I'm curious -- why don't you own MLPs personally? Do you see something in the horizon that will make them a better buying opportunity? It seems that the institutional dumping that went on last week might have been about as perfect of a storm as you're going to get.

2008 Oct 17 10:39 AM