Seeking Alpha

Master Limited Partnerships - Fallen Angels Or Stagnant Stars?

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Includes: BEP, BIP, BPY, BX, DKL, EPD, ET, EVA, FEN, HMLP, KYN, LMRK, MMP, MPLX, OKE, PAA, PBFX, PSXP, TCP, TYG, USAC, USDP, WES, WLK
by: Real-Time Retired Guy
Summary

I have owned MLPs since the early 2000s when they flew under most folks' radar.

Over the years, I have watched as MLP numbers ballooned to over 100 and have now contracted in recent years due to mergers, acquisitions and "take unders".

I have grown increasingly concerned that while many MLPs continue to faithfully increase distributions, these increases are now occurring at a slower rate.

In this article, I present my personal take on the future of the MLP sector, its position within the Protected Principal Retirement Portfolio (PPRP), and my outlook on the sector going forward.

A Little History

I "discovered" MLPs just after the turn of this century when I became intrigued with Teppco, one of the quality midstream companies. A while after I purchased a position, Enterprise Products Partners (EPD) came along and acquired the company - at a decent premium to the unit price (not at all like today's M&A MLP activity).

That was the time that I decided to dig into these "MLPs" to figure out what they actually did, how they operated and, more importantly, to determine if I should expand my holdings in the sector. The results of my research indicated that expanding holdings in the sector was definitely warranted, particularly since total returns were being generated at about 15 percent per annum.

My research indicated that there were upstream (exploration and production), midstream (pipelines) and downstream (storage and terminalling) MLPs, with the upstream ones affording the highest risk (and the highest yields).

While the number of publicly traded MLPs back then was far smaller than it is now, the opportunity for diversification within the sector was still present.

Over the next several years, I built a significant position in the sector, but EPD always remained far and away the largest percentage component in my portfolio. By 2008, I owned more than 15 different MLPs, and it seemed like as I bought more of them, more started publicly trading. While the greatest percentage of my money was in the midstream and downstream MLPs, I was sucked in by the higher yields (and potential returns) of the upstream ones - big mistake there.

In the bear market of October 2007 to March 2009 (and for some time thereafter), many of the upstream MLPs crashed horribly and/or went into bankruptcy. A fair number of the midstream and downstream MLPs also crashed price-wise, but the sound ones (read investment-grade) continued to increase, or maintain, distributions through the worst of the storm. I was fortunate in that I selected a few that I really liked (like EPD) and doubled down in the latter part of 2008 and early 2009.

Fast-forwarding to about 2015, my MLPs continued to recover and, in many cases, moved back above pre-bear market levels. The other factor of note during this period was the rather large increase in the number of MLPs that came to market. There were probably over 100 to choose from, and yields well above eight percent were not uncommon.

Another sea change beginning around this time was that total returns came to be dominated not by unit prices plus distributions, but by distributions alone. That, coupled with the fact that MLPs were no longer under the radar, prompted me to become a bit concerned about the future of the sector. While it's nice to receive a seven or eight percent annual distribution, it is also nice to achieve some unit price appreciation as once was the case.

Since 2015, the MLP sector has been in the doldrums, and it seems that the majority of the investment community doesn't even care about them anymore. Add to this the recent M&A and "take under" activity (I roughly define a "take under" as an acquisition of an MLP at a highly depressed unit price while offering a ridiculously small premium to the unit price and tying the acquisition price to a percentage of the acquirer's unit price), and it is understandable why the sector is unsteady.

Over the past few years, the PPRP's MLP holdings have been reduced to about nine. Of the nine, I really feel good about five and am marginally concerned about the other four. For the record, here are the ones I currently hold: Delek Logistics Partners (DKL), EPD, Energy Transfer (ET), Enviva Partners (EVA), Hoegh LNG Partners (HMLP), Landmark Infrastructure Partners (LMRK), PBF Logistics (PBFX), USA Compression Partners (USAC), and USD Partners (USDP). Those in the "really feel-good" category are: DKL, EPD, EVA, PBFX, and USDP. One of the lessons that I think I have learned over the past five or so years is that it is possible to diversify beyond just midstream and downstream MLPs within the sector. I think that EVA (renewable resource) is a prime example, as is HMLP (liquid natural gas and floating storage and regasification units, or FSRUs), LMRK (a hybrid MLP/REIT partnership), USAC (compression services - betting on a recovery here), and USDP (rail storage and logistics).

From time to time, I have been successful in writing covered calls against one or more of these without having to surrender any of the positions. I have been most successful writing covered calls around DKL, which has traded around the $30 level for at least a few years.

So, that sums up my history as an MLP investor. Now let's turn to my personal opinion on this sector going forward a few years.

Wither Thou Goest, O MLPs?

As I work on this article, I am waiting to see the impact of the Iranian bombing of Saudi oil resources on both the markets and MLPs specifically. I note that after the open this morning (Monday), MLPs gapped up, but they are slowly inching their way back. I don't know if this event classifies as a "black swan", but it could be positive in the near term for the MLP sector.

Since 2015, the MLPs as a whole have been a conundrum - pretty much dead money, except for the distributions. In fact, many have acted like a higher-yielding bond, which for some retired folks is enough to make them happy.

My personal take is that the indifference to MLPs is due to a combination of:

  • Fear of the "take under", which, based upon recent actions of the Kinder Morgan group and the Energy Transfer group, is probably warranted.
  • Concern about filing K-1s annually (which is not nearly as difficult as it seems).
  • The large number of upstream MLPs that have crashed and burned.
  • Distribution cuts and subsequent yield reduction.
  • Lack of institutional buying interest.
  • The lack of participation by the sector in the recent years of the bull market.

Hey, what's not to like?

I believe the recent stagnation in the sector is due to a combination of all of the above, plus some other factors that I have not listed.

From a personal standpoint (as a retired guy), I believe that my reducing exposure to the MLP sector is completely warranted. For some of you who have different goals, the situation might be different. Either way, I think any portfolio exposure greater than 15 percent is very risky.

So, Just How Does One Decide Which MLPs To Buy?

There is a wealth of information out there for those interested in researching or buying MLPs. More and more financial metrics are available to assist in their evaluation, for those interested in doing some original research (wouldn't buy these without at least a basic knowledge as to how they function). There have been a multitude of articles on SA that go into great depth on the sector, so I needn't repeat it here, but for those interested, I would recommend the following:

  • Monitor the quarterly distribution announcements - most are made in January, April, July, and October, with distribution pay dates in February, May, August, and November (there are a few exceptions)
  • Read the quarterly earnings reports - look at quarter-over-quarter and year-over-year comparisons - particularly the line item entries for distributable cash flow (DCF), which should be continually increasing, and the DCF coverage ratios (should be >1.10X). For MLPs, these data are similar to that of a stock's net investment income being able to cover the company's dividend payment.
  • Keep an eye on commodity prices - both oil and natural gas. Most MLPs track these to varying degrees.
  • I like spending time daily reading posts by several folks on the InvestorVillage MLP page. As with any message board site, there are some screwball posters, but there are at least half a dozen very smart folks residing here - you will be able to spot them in a day or so. When you go to this board, you will notice in blue below the green line "Links". There is a listing of articles, analysts' commentary and spreadsheets, and K-1 tax information that will provide you with more information that you ever need. In particular, the Sector List, Alpha List, Distribution History, Price History, and MLP Distribution SS encompass key financial metrics. There is also a link to SA Articles on MLPs.
  • MLP evaluative techniques are evolving, mainly (I think) because recent distribution cuts by high yielders have resulted in DCF coverage ratios being "artificially" inflated. Linked here is an article from April 2019 that appears on Alerian's website which gives some insight into more current methods for evaluating MLPs.

For those of you wishing to initiate or increase MLP positions, I suggest that you try to diversify within the sector, i.e., focus on investment grade midstream and downstream MLPs, and include MLPs outside of those dealing solely with oil and natural gas - renewable resources, LNG, logistics etc. Here are some links to help get you started:

By sticking with investment grade MLPs, there is a lesser chance of distribution cut and a greater chance that distributions will be either maintained or raised even during a market correction (or worse). A partial list of investment grade MLPs/C-Corps etc. includes the following: EPD, ET, Magellan Midstream Partners (MMP), MPLX LP (MPLX), Plains All American Pipeline (PAA), Phillips 66 Partners (PSXP), ONEOK Inc. (OKE), TC PipeLines (TCP), Western Midstream Partners (WES), Westlake Chemical Corp. (WLK), Brookfield Infrastructure Partners (BIP), Brookfield Property Partners (BPY), Brookfield Renewable Partners (BEP), and The Blackstone Group (BX), among others. Resist the temptation to chase too many high yields - that is usually asking for trouble. Although I own a few higher-yielding ones, I have small positions and am looking at turnaround opportunities.

An Alternative Way To Invest

As I mentioned earlier, I have nine MLPs - which, to me, is enough individual positions. I have made the decision that if I were to expand my MLP holdings, I would look to closed-end funds, since they offer an easy way to gain portfolio diversification. They are not without risk, however. Several closed-end funds have had to cut distributions in recent times - I think because these were overweighted to the higher-yielding MLPs. The fund screener on CEFConnect shows 23 MLP closed-end funds currently trading. Yields on these range from 7.50 percent to a whopping 33 percent. All of these use leverage, and the fees generally run higher than for other types of closed-end funds.

I like to look at two data points before researching details on individual funds. These are: the Return on NAV Since Fund Inception and the Return on Market Price Since Fund Inception. Since many of these funds were brought to market since 2015, their returns are not very impressive. Tortoise Energy Infrastructure (TYG), First Trust Energy Income & Growth (FEN), and Kayne Anderson MLP/Midstream Investment Company (KYN) have generated the highest returns in both the categories.

The top holdings of all three of these funds are investment grade. I suggest that you delve deeper into the balance of the MLP funds to make sure of their suitability with respect to your risk tolerance.

For those of you who wish to avoid K-1s and are familiar with evaluating closed-ends funds, I suggest you look to them as opposed to purchasing individual MLPs.

Conclusion

Although this article only scratches the surface of MLP investing, it is my hope that it at least points you in the right direction. I have tried to present a capsule summary of where I stand, where the sector could be headed, and how to go about doing some valuable research before proceeding with purchases.

I believe that the MLP sector has undergone change and will continue to do so, at least until the present wave of consolidation and changeover to C-Corps is finished. I could be very wrong, but for the next three years or so, I think they will mostly remain like higher-yielding bonds, with total return being a secondary but minor benefit. It would be nice to be wrong in the assessment.

Disclosure: I am/we are long DKL, EPD, ET, EVA, HMLP, LMRK, PBFX, USAC, USDP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.