Picking The Right MLP

Barron’s published a panel discussion on MLPs this past weekend. The panelists debate whether MLPs are still attractively valued or not and their sensitivity to rising rates. Although MLPs have been very strong this year, with our MLP Strategy +23% year-to-date, we continue to think that distribution yields of 5-6% and conservative growth prospects of 4-6% (implying a total return of 9-11%) make this a good asset class for the long term investor.

It’s important to pick the right names though as in any investment strategy. Because MLP investors are driven in part by the tax deferral treatment of the distributions, this is also not a sector that lends itself to much trading or switching out of names. Indeed, a well-managed MLP portfolio should be the most parsimonious user of brokerage services, because it should have minimal turnover. Selling an MLP typically triggers a taxable gain, and as time goes by the hurdle a new investment must clear in order to justify the tax bill incurred by selling an old one can become almost insurmountable. Earlier this year one friend suggested MLPs were due for a correction and noted a well-regarded MLP investment manager was selling. In our analysis we found that for some long-standing accounts it would have required that the cash thereby raised be reinvested at prices 20% lower simply to break even on the taxes incurred through selling in the first place. Meanwhile, the manager’s track record would not show the after-tax return. His clients could be worse off even while his track record looked as if timing had helped them. As it turned out though, this Spring correction was only around 2% so not worth the trouble.

Some MLPs offer very high but fluctuating yields. Petrologistics, LP (PDH) is an example. They convert propane into propylene, and so their earnings are highly sensitive to the price spread between the two. Their current distribution yields is 9.8%. Their 2011 S-1 registration statement warned of wide fluctuations in their distributions depending on business conditions. Their most recent 10K noted that, “We may not have sufficient available cash each quarter to enable us to pay any distributions to our common unitholders.”

It’s not just that LP investors are typically looking for stable yields and that PDH does not promise that. The additional challenge is that there are probably times to own PDH and times to be out of it. More frequent buying and selling reduces the amount of capital available for an investor to deploy because of taxes.

The Barron’s article mentioned other MLPs with more volatile business models, such as CVR Refining (CVRR). Refining can be a feast or famine business depending on margins which fluctuate widely. CVRR’s current distribution yield is an eye-catching 20%, although there’s clearly some doubt about its sustainability since management recently lowered its guidance.

There was also an interesting piece on Seeking Alpha this morning on StonMor Partners, LP (STON). STON is not in the energy business at all, but is in “deathcare”. They operate cemeteries and funeral homes. For historical reasons they operate as an MLP. The 9.6% distribution yield is attractive, although we’ve never invested because we found the financial structure overly complicated. Managing cemeteries is somewhat similar to running an insurance business, in that you get to invest the float. In STON’s case, people buy cemetery plots with cash and the maintenance costs of the cemetery are spread over many years.

The Seeking Alpha article notes the absence of much insider ownership or even institutional ownership, and asserts that distributions are persistently funded with issuance of debt, rather than out of profits. The writer believes a distribution cut is likely.

If any of these names mentioned above cut their distribution because of insufficient cash, as a friend of mine has said in the past, “Down’s a long way from here.”

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
0 replies

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.