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Distribution Growth for MLPs Should Continue as Long as Credit Conditions Remain Strong

September 12, 2012 | About:
On Dec. 26, 2008, the Alerian MLP Index finally bottomed, having lost roughly half its value amid a collapse in commodity prices and the worst financial crisis since the Great Depression.

In the subsequent three and a half years, the benchmark has almost doubled investors’ money, generating almost twice the return of the S&P 500 over the same period. However, this impressive performance was less than half the return of my favorite closed-end mutual fund, Kayne Anderson Energy Total Return (KYE).

Is another rally in store for MLPs this year? With valuations on many names appearing overextended, the Alerian MLP Index has lagged the S&P 500 by about 9 percentage points. Meanwhile, many upstream MLPs have seen their unit prices decline amid weak prices for oil, natural gas and natural gas liquids (NGL).

Distribution coverage ratios among upstream operators and MLPs that own natural gas-processing assets have also come under pressure because of weak commodity prices and challenges hedging against the sharp decline in NGL prices that occurred between April and June 2012. My colleague, Peter Staas covered the challenges facing gas plants in his excellent article, Processing Second-Quarter Results.

MLPs that own coal-related assets also suffered a diminution in distributable cash flow, as the price of domestic thermal coal remained under pressure and producers curtailed output because of electric utilities’ elevated inventories.

Meanwhile, MLPs continue to enjoy extraordinarily favorable conditions for financing the construction and acquisition of new assets. For example, Enterprise Products Partners LP (EPD) last month sold 30.5-year bonds with a coupon yield of only 4.45 percent and three-year notes with a yield of 1.25 percent–impressive placements from a company that has a BBB- credit rating from Fitch.

Equity offerings and credit facility extensions have been no less successful. By and large, MLPs have avoided near-term debt maturities that would make them vulnerable to a sudden tightening of credit conditions.

MLPs’ pipelines of new projects also remain robust. Despite volatile energy prices, North American exploration and production firms continue to ramp up drilling activity in oil- and liquids-rich plays, overwhelming existing midstream capacity. All this adds up to a bull market for MLPs, which continue to book capacity commitments on infrastructure projects well in advance of construction.

As long as MLPs enjoy access to inexpensive capital and an abundance of growth projects, the torrid distribution growth of recent years should continue. However, you should also remember that even the best MLPs will occasionally suffer from lumpy results and that the group will sometimes take a breather when market sentiment shifts.

About the author:

Roger Conrad
Investing Daily provides stock market advice and investment newsletters to help independent investors achieve a secure and rewarding financial future. The site’s coverage focuses on finding the most profitable emerging trends in the investment universe to bring investors pragmatic and in-depth coverage of the names that are taking advantage of these opportunities.

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