Midstream MLPs: The Master of Yields interrupted by negative sentiment
The Master of Yields interrupted by negative sentiment
Summary
• Master limited partnership (MLP) distributions continued to grow in Q4 2015.
• MLP valuations are attractive when assessed by appropriate valuation metrics.
• Midstream MLPs’ revenues are more resilient to oil price fluctuations than upstream oil companies’ revenues.
• Yet they are trading more like upstream oil companies. We believe there is potential for an upward correction as MLP resilience becomes apparent.
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The MLP structure remains intact
Master limited partnerships (MLPs) are tax exempt limited partnerships that are required to pass through majority of their earnings as distributions to investors. A confluence of factors from restrained capital market access, declining oil prices and fears of rising interest rates have seen the price of MLPs fall by more than 46%. We believe that this price reaction has been overdone. Negative sentiment over single MLPs such as Kinder Morgan, which became overleveraged after the additional purchase of 30% of Natural Gas Pipeline Company of America LLC, appear to have affected the sector at large. However, we see sustainable distributions and low valuations opening an attractive entry point to this sector.
For the purpose of this report MLPs refer to the 24 constituents (as on 12 Feb 2016) of the Solactive US energy infrastructure total return index.
Sustainable distributions
In their latest fourth quarter 2015 results MLPs have reported a 15% growth in quarterly distributions over the prior year allaying widespread concerns of distribution cuts.
Attractive valuations
When analysing distribution yields, we believe it’s vital not to view MLPs in isolation. We can draw a comparison to both utilities and real estate investment trusts (REITs). Utilities and MLPs are known to derive their primary source of earnings from services indelible to society that have high barriers to entry. In fact utilities were the original owners of many of the assets from which today’s MLPs are formed. Real estate investment trusts (REITs) and MLPs can be linked by their ownership of tangible, long lived assets ruled by underlying contracts that provide a stable income stream. MLPs also have a similar structure to REITs that escape being taxed at a corporate level. Midstream MLPs currently offer a 6% distribution yield, attractive relative to history of earnings yields of similar assets. The current low interest rate environment has investors searching for yield from non traditional sources, supporting the case for MLPs.
Despite MLPs’ greater revenue resilience to oil price, they have been trading more like upstream oil companies and we believe that there is potential for an upward correction in their price when this becomes more apparent to the market.
Conclusion
In light of the above discussion we believe midstream MLPs are trading at levels that reflect the distress in the energy sector. By virtue of the resilience of their revenue streams, current valuations on EV/EBITDA basis and managed debt levels, midstream MLPs are well positioned to appreciate given a turnaround in stressed capital markets and sentiment.
For more information contact:
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E infoUK@etfsecurities.com
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