It’s the Distributions, Stupid!

Jim Carville’s admonition during Bill Clinton’s 1992 run for President was, “It’s the economy, stupid!”

In its August 2018 edition, The Utility Forecaster warns readers to approach MLPs “with caution.” Too risky for income investors is their conclusion. MLP buyers have been badly abused, and Chief Investment Strategist Robert Rapier reminds readers of the many “simplifications” that triggered unwelcome tax bills, as well as the multiple distribution cuts. Without doubt, MLP prices have followed distributions.

In one important respect though, Rapier adopts a simplistic yet incorrect explanation. “…during a long downturn in oil and gas prices, contracts expire and MLPs had to renew agreements under less favorable terms. Many MLPs found themselves doing what was once unthinkable – they had to cut distributions.”

It’s conventional wisdom that the 2014-15 oil collapse hurt pipeline company operating earnings, which caused payout cuts. But the numbers don’t support this narrative. The Kinder Morgan (KMI) chart below shows their Distributable Cash Flow (DCF) per share alongside a significantly more volatile stock. KMI’s DCF per share is little changed from 2015 to 2016, but the share price fell by half. They cut their payout twice: once when combining Kinder Morgan Partners (KMP) with KMI (“simplification”, in which KMP investors received KMI stock with a lower payout as well as a tax bill); and again later when KMI cut its dividend. KMI was learning that MLP investors want income over the promise of growth.

To fund their growth projects, KMP was paying out most of its DCF and then seeking to recoup some of it through secondary offerings.  In effect, investors were being asked to reinvest a portion of their distributions back into the company. Many holders found this unattractive, since they spend the income. So KMP’s yield rose, which made issuing equity too expensive. KMI concluded MLP investors no longer suited their purpose, and left to become a corporation. Today, KMI yields 5.1%, with a payout more than 2X covered by its $4.7BN DCF.

MLP buyers can be focused on distributions to the exclusion of anything else. Two recent examples highlight:

In late July, American Midstream Partners (AMID) slashed its distribution by 75% so as to, “…significantly reduce leverage, provide capital for strategic growth opportunities, and create long-term value.” Although these all sound like desirable objectives for a total return investor, AMID’s stock fell 43%.

Meanwhile, Hi-Crush Partners (HCLP) tripled its distribution and now yields 23%. The higher payout is unlikely to persist, but if it’s sustained for a year the company will convert to a corporation. Whether or not this is good for investors, its stock rose 28% on the day of the announcement.

MLP investors want their income.

The chart from Bank of America is even more striking. On the MLPs they cover, they show steadily growing EBITDA with improving leverage, alongside a declining Alerian MLP Index. Falling MLP distributions clearly drove index performance more than improving financials.

EBITDA vs Leverage

It’s as if MLP investors look at payouts and little else.

Probably the simplest measure of MLP payouts is to look at dividends on the Alerian MLP ETF (AMLP), which are 30% lower than in 2015.

There were nonetheless some companies whose operating performance sagged. Plains All American (PAGP/PAA) relied in part on its Supply and Logistics division to support its distribution. When arbitrage opportunities dried up in 2016-17, almost $800MM in EBITDA evaporated, leading to a second distribution cut. Today, increased Permian volumes are boosting cashflows once more. On last week’s earnings call they forecast 2019 EBITDA growth of 14-15%.

But episodes such as PAGP were the exception – operating results for the most part held up.

As memories of the 2014-15 bear market recede, we believe the conventional explanation for it will shift. MLP prices didn’t collapse because of weak operating performance. They fell because DCF was redirected to pay down debt and finance new projects, all to achieve growth (see Will MLP Distributions Pay Off?). Income seeking MLP investors don’t want their income redirected in this way. Hence, persistently weak MLP prices which have led the shift to a corporate structure for those companies wishing to access a far larger pool of buyers.

BofA Merrill is forecasting 2016-20 distribution growth for 27 of the 32 midstream infrastructure names they cover. JPMorgan forecasts 6-10% growth 2017-19. We expect our American Energy Independence Index to grow its dividends by 9% this year and 11% in 2019.

These forecasts are supported by growing pipeline demand. There are bottlenecks in moving crude oil and natural gas out of the Permian Basin in west Texas, and in getting natural gas out of the Marcellus in Pennsylvania. New pipelines to transport Canadian heavy oil from Alberta continue to face political challenges. The Shale Revolution is driving volumes higher.

With pipeline demand and dividends both growing, the sector is poised to continue its rally.

We are invested in KMI and PAGP. We are short AMLP.

Includes corrected text and a revised chart compared to an earlier version, with respect to Kinder Morgan

Print Friendly, PDF & Email

Important Disclosures

The information provided is for informational purposes only and investors should determine for themselves whether a particular service, security or product is suitable for their investment needs. The information contained herein is not complete, may not be current, is subject to change, and is subject to, and qualified in its entirety by, the more complete disclosures, risk factors and other terms that are contained in the disclosure, prospectus, and offering. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy,  completeness or timeliness of this information. Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments.  Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.

References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and do not reflect the deduction of the advisor’s fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios managed by SL Advisors as they have different underlying investments and may use different strategies or have different objectives than portfolios managed by SL Advisors (e.g. The Alerian index is a group MLP securities in the oil and gas industries. Portfolios may not include the same investments that are included in the Alerian Index. The S & P Index does not directly relate to investment strategies managed by SL Advisers.)

This site may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involves a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of SL Advisors LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made. r

Certain hyperlinks or referenced websites on the Site, if any, are for your convenience and forward you to third parties’ websites, which generally are recognized by their top level domain name. Any descriptions of, references to, or links to other products, publications or services does not constitute an endorsement, authorization, sponsorship by or affiliation with SL Advisors LLC with respect to any linked site or its sponsor, unless expressly stated by SL Advisors LLC. Any such information, products or sites have not necessarily been reviewed by SL Advisors LLC and are provided or maintained by third parties over whom SL Advisors LLC exercise no control. SL Advisors LLC expressly disclaim any responsibility for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on these third-party sites.

All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.

Past performance of the American Energy Independence Index is not indicative of future returns.

Print Friendly, PDF & Email
1 reply

    That’s a good analysis. Of course, Rapier ignored those MLPs which, during the bad times retained their distributions (USAC is one of them) and even increased them regularly (like the ever reliable EPD). Moreover sometimes cuts lead to a structural strengthening which resulted in stability and then to positioning for future distribution increases (CEQP comes to mind). And then there are the new MLPs which have a path to significant distribution growth for years to come ( look at OMP). The point, which Rapier ignores but which your article makes clear, is that it all depends on management. AMID’s collapse was predicated on several serious missteps due to management failures.


Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.