Is the MLP Sell-Off Over Yet?

Includes: EPD, ETP, KMP, OKE
by: MLP Trader

In my February article, "Master Limited Partnerships: Pipe Dreams or Shark Jumpers?" I wrote:

I think that great run is coming to an end. No, I’m not liquidating. Many of my holdings have zero cost basis, so the tax consequences are prohibitive...Going forward, I expect very long-term returns to be positive, but modest. Along the way, there is likely to be a really bad-ass correction.

Those comments elicited contumely from a few SeekingAlpha readers, so it's worth looking at recent history. Here's the Alerian MLP index for the last month. Click to enlarge:

The index lost about 10% in little more than two weeks. Yesterday some MLPs were off an additional 8-10% intra-day. Is that the "bad-ass" correction? If so, is it over yet?

The short answers are "no" and "probably not." While a few names have gotten closer to attractive levels, if we look at the entire sector, the price level is only back to where it was at the beginning of the year and still nearly 30% above the level of a year ago. Click to enlarge:

What seems like a terrible correction is little more than a blip in the longer term perspective. In the aforementioned article, I noted that the yield of Enterprise Products Partners (NYSE:EPD) was only 100 basis points above 30-year Treasuries. The spread is still only 180 basis points, and part of that is due to Treasury yields dropping 50 basis points since I wrote the article. That 180 basis point spread is still well below the historic average. And who really expects Treasury yields to remain this low for long?

As I discussed in a previous article, longer term holders should think carefully before liquidating their MLPs. The tax implications of selling can be significant. If you are an income investor, it makes sense to consider what I call "Return on After Tax Proceeds" (RATP). RATP is a more precise and useful concept than the popular "yield on cost." Here's how it works: if I sell my units of EPD, I would expect to pay roughly 35% in Federal and state taxes. RATP is calculated thusly:

  • EPD price: $39.60
  • EPD distribution: $2.39
  • Current yield: 6.04%
  • Proceeds from sale: $25.74
  • RATP: $2.39/25.74 = 9.28%

In short, if I want to replace the income I'm getting from EPD, I need to find a stock that yields 9.28%. That's a pretty high hurdle.

What to do Now
So liquidating at this point makes no sense to me. What about buying? We are seeing what appear to be forced liquidations in individual MLPs. I've heard from clients of a certain broker that they've previously experienced margin liquidations at 9:45, which sheds a little more light on the precisely-timed 9:45 sell-offs we saw in several MLPs last week. These present great trading opportunities, where you can fill a stink-bid and then sell the stock back a day or two later for a 5% gain.

Anyone who actively traded MLPs in 2008 and 2009 can vouch that the extreme leverage employed by hedge funds in this sector can result in chain-reaction liquidations that can drop even the large-cap MLPs by 10% or more in a day. But that aside, if you look at the key metrics for MLPs--distributable cash flow, growth rates, yields--they simply aren't that compelling at this point, particularly if you see Treasury yields rising as I anticipate. It's a great time to trade, but it's not time to jump in with both feet. Not yet.

Disclosure: I am long KMR, EPD, OKS, LINE, BWP, ECT, BBEP, STON.