Kate Stalter: I am speaking today with Brian Watson, director of research and portfolio manager at SteelPath.
Brian, energy master limited partnerships, which SteelPath has a specialty in, attracted quite a bit of investor attention late last year and early this year. Describe how these investments differ from other mutual funds, and what some of the advantages for investors might be.
Brian Watson: The MLP asset class has really become home to the pure-play energy infrastructure provider, similar to how the REIT structure became home to real estate. So what attracts us to the asset class is really that business profile.
Obviously MLP just stands for structure, and there are entities that use that structure that we don’t necessarily consider energy infrastructure, and so we try to avoid those. But it is really just this backdrop of the wind at its back for energy infrastructure providers.
To kind of categorize it, we describe these entities as being cash cow-like, so very robust earners of cash that they can pass through as distributions or dividends to their holders. Stable margins, but at the entity level they are growing at pretty interesting paces.
The reason why they are growing is a handful of reasons: One, there is still a tremendous amount of these energy infrastructure assets—pipelines, terminals, and you could go on and on. But these more boring logistical assets that stand between the wellhead out in West Texas and the city gate in New York or whatever. So it is all those assets in between, and they are characterized by charging a fee for moving volume or storing volume
So, therefore, you don’t really care what the price is of the commodity, as long as it is flowing, so that is the type of assets we are focused on. Today, obviously MLPs own a lot of them, but a lot of those assets are on, for an example, exploration and production balance sheets. So the original builders of those assets still own a lot of those assets, but they don’t get any credit for it.
No one cares what Chevron’s (NYSE:CVX) pipeline arsenal looks like…people look at their reserves, so that is where those equities tend to trade at. So those managers know that they are better off selling those energy infrastructure assets to an MLP.
MLPs trade at nine, ten, or 11 times multiples. E&Ps trade at five or six. So there is this obvious economic incentive to sell those assets from corporate holders to MLP holders. That is a big reason why the sector has grown over the past ten years, and continues to help entities grow.
Now add onto that the fact that we have got, for the first time in a generation, growing crude oil production, growing natural gas production, and growing natural-gas liquids production. There is a whole new opportunity set for those in the energy infrastructure world to build business and earn rising margins.
Of course, the most obvious in that environment, where these production volumes are actually going up, is the chance for a pipeline owner to take utilization of a pipeline from 40% to 42% to 45%. Of course, all that incremental volume pretty much goes to the bottom line; there is very little additional cost.
So overall, the sector is really benefiting from this shift from the constant declines that the energy world has faced over the past 30 years to now increasing production volumes.
And then secondarily, and very powerfully, is the need for new infrastructure assets. The MLP sector spent something like $16 billion last year building new assets, and we think they will spend the same amount of money this year. If you look at the past five years, the total was about $60 billion…so really a huge of opportunities to build new assets.
So you throw all these things together, and you take these standalone boring assets when you put them under an entity that’s adding by buying new assets, adding by building new assets, and benefiting from increased volume, they are buying some pretty interesting growth prospects.
For example, today we think distribution growth for the sector as a whole will approximate 7% for this year, 2012. Last year, it was right around 6%, just about 6%. So for an otherwise pretty boring cash-cow entity, those are pretty attractive growth rates.
Kate Stalter: One of the things that attracted individual investors to the MLPs has been the yield that they are able to get. Can you say a little bit about that?
Brian Watson: Yeah, you know the yield is really a byproduct of the way the asset class has developed. Again, these are cash-cow entities, very little maintenance required. It has always been a yielding asset class.
If you go back to the beginning stages of the asset class, growth wasn’t a very big contributor to total return; they would be kind of standalone pipelines dropped into a standalone MLP. Really what it had offered investors what this cash-cow aspect, this large cash-earning and little-maintenance-capex-requiring asset class.
So yield just became part of their MO; that yield component and the fact that they pay out most of their cash earned has remained. Most MLPs maybe will retain 10% or 20% of cash earned in any quarter, and distribute the rest of it, with capex being funded through issuing new equity or going back to the capital market. It is just the way the sector has grown up.
To me, we think it instills in these management teams a lot of discipline. They know that if they are going to spend money and raise equity, or go to the fixed-income markets to finance it, it better be accretive.
Again, 90% of cash earned is paid out in distributions, so if one of these management teams does something that is not cash-accretive, it becomes very apparent very quickly. So I think over time, it has really forced a lot of discipline on these management teams.
Kate Stalter: The flagship fund of SteelPath is called the MLP Alpha Fund. Brian, can you say a little bit about some of the holdings in that fund?
Brian Watson: The Alpha Fund is our total return-focused fund. Obviously it has a yield that is attractive, just like the whole sector does, but we are kind of yield-agnostic when it comes to picking stocks for that fund. We are just looking for the best total return opportunities.
Buckeye Pipeline Partners is kind of a company in transition. They have been kind of a slower grower historically, but they have got some new management in. They have spent several billion dollars on what we think will turn out to be very attractive projects as they mature and complete some build-out related to those.
So we see that entity, really to 2013 and back out to 2012, start to provide some really attractive distribution growth and just trading at what we see is a very nice multiple.
Plains All American Pipeline is one of the largest gatherers and handlers of crude oil production in the United States; we kind of touched on that briefly. Again, we are experiencing a revolution in production in the United States through horizontal drilling, fracking, and these newer technologies, and they are able to capitalize on that wonderfully because of their domestic crude oil footprint.
El Paso Pipeline Partners is a natural gas pipeline owner, primarily of El Paso’s (EP) pipeline assets. We expect them to continue to benefit from really that first wave of growth, which is assets going from a corporate balance sheet to the MLP balance sheet. It might potentially have some upside related to an acquisition of its parent company.
So each of those offers a little bit of each one of those growth avenues we talked about.