Deja Vu All Over Again for Pipelines?

Years ago, before the Shale Revolution became the phenomenon it is, comparisons were often made between MLPs and REITs. Both offered attractive yields from real assets, and income-seeking investors were drawn to them.

As a result, their performance tracked each other pretty closely. Investors focused on the relative value of one versus another generally kept them in line. This was the period when pipelines earned their reputation as “toll-models”, driven by volumes with little relationship to crude oil.

REITS and Pipelines Move Together

Long-time investors in energy infrastructure fondly remember those days and many retain mixed feelings about America’s resurgence in oil and gas production. MLPs embraced growth projects, and payouts to investors soon suffered.

It’s worth recalling the pre-2014 era, because pipeline stocks are resuming dividend growth once again. The growing realization has already led to a strong start to 2019, with the sector up almost 20%. Comparisons with REITs or utilities made little sense for investors seeking income when MLP income was uncertain. The 36% drop in payouts from the Alerian MLP ETF (AMLP) reflect a big betrayal, but not a collapse in the business. Nonetheless, as we’ve often found when talking to investors, distribution cuts for any reason tend to drive them away.

Enterprise Products (EPD) CEO Jim Teague reflected the mood when he recently said, “So many of these guys cut their distributions. I wouldn’t buy their stock either.” Reliable payouts matter.

Since 2014 MLPs and REITs have maintained a loose relationship, and although the economic link between crude oil and pipeline company profits is generally weak, at times they have been manacled together. Some investors will ruefully add that the link is strongest when crude oil is falling.

REITS and Pipelines Part Ways

Rising pipeline distributions reflect an acknowledgment of investors’ requirement for greater capital discipline with predictable payouts. Growth capex for the industry was $55BN last year and looks likely to be lower this year, freeing up cash. Several big projects are nearing completion, which will further support cashflows.

Internally funded growth is the new normal. The older, wealthy Americans who are the main direct investors in MLPs have demonstrated resoundingly that they don’t want to finance growth. It’s why there were no MLP IPOs last year. Leverage is down to 4X Debt:EBITDA.

Energy infrastructure stocks offer compelling value versus REITs. Distributable Cash Flow (DCF) yields of 10-11% are growing 10% annually in the broad-based American Energy Independence Index (this is 80% corporations and 20% MLPs). REITs offer yields from Funds From Operations (cash generated from existing assets before growth capex, similar to pipeline companies’ DCF) of around 6% with little growth.

DCF Yields REIT vs AEITR

Income stability should draw more REIT investors to consider pipelines, which will restore the close relationship the two sectors shared for many years. This in turn will further weaken the link to crude oil.

MLP Yield Spread vs. REITS

The energy sector’s collapse in 2014-16 caused MLPs to fall more than they did during the 2008-9 financial crisis. Memories of that episode remain fresh, but many signs suggest that the stability of earlier years is returning.

Join us on Thursday, March 21st at 1pm EST for a webinar. We’ll review the prospects for continuing growth in US oil and gas production. To register please click here.

We are invested in EPD and short AMLP.

SL Advisors is the sub-advisor to the Catalyst MLP & Infrastructure Fund.  To learn more about the Fund, please click here.

SL Advisors is also the advisor to an ETF (USAIETF.com)

1 reply
  1. Elliot Miller
    Elliot Miller says:

    Regarding the quote from Jim Teague, whom I as an EPD unit holder greatly respect, the reduction of a distribution is not always a fatal event for an MLP. Several years ago CEQP reduced its distribution (and eliminated its IDRs), and the unit price plummeted after the distribution reduction. New management was brought in, the business model and capital allocation were refined, the partnership is prospering, EBITDA growth is at 15%, and the unit price is strong.
    And there is an interesting phenomenon which is a corollary to the text. Natural gas oriented partnerships also tracked crude oil prices on the way down. The relationships are indirect: Permian and some other basin gas is associated, and NGL prices often track crude, but these are indirect effects at best, and yet crude oil prices impacted natural gas oriented midstream operators.
    And for we MLP investors (allegedly old rich guys) there is another benefit which should be mentioned. Thanks to depreciation, partnership distributions are largely or entirely tax deferred and while one’s adjusted basis is reduced thereby when we old guys die our heirs benefit from a stepped up basis.

    Reply

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