Daves Thoughts of the Week

With the tremendous sell off in MLPs over the last 18 months, one would expect that many of them would have cut their distribution payouts.  In that case, fundamental performance would be more aligned with stock performance.   However, the opposite is actually true.  A little under half of midstream MLPs have announced increased distributions. One midstream MLP  suspended its distribution, while another cut theirs by 25%.  Meanwhile, a little over 50% of MLPs have kept distributions even with the previous quarter’s.  Both of those MLPs had poor financial metrics. The ability of an MLP to maintain or increase its distribution is dependent on its debt level and its coverage ratio.

The coverage ratio is the amount of cash which could be distributed divided by what actually is distributed.   The debt is usually measured by debt to EBITDA – the lower the better.  In today’s environment, when MLP unit prices are at multi-year lows, the prospect of selling units to finance growth is generally unacceptable.  MLP unit prices have followed the price of oil and many MLPs are priced irrationally.  We are focused on discovering and investing in MLPs that are undervalued and will continue to pay strong and growing tax deferred distributions for the long run.

U.S. shift towards energy self-reliance bolsters MLPs

The U.S. currently holds a preeminent position in the Energy world, partially due to our ability to retrieve natural gas and oil from shale. There are four main criteria that have contributed to this unique situation:

  • Water
  • The property rights of individuals
  • Infrastructure
  • Drilling technologies (fracking and horizontal drilling)

The U.S. is unique in that we have all four essential elements to produce oil and natural gas from shale. The combination of factors has proved quite advantageous, as some industry experts estimate that roughly 90 percent of oil and natural gas is contained in shale formations, with the remainder held in pools.

While drilling for oil used to be hit or miss, the focus on shale – which can be located using sounding techniques and other methods – has made extraction more reliable. Our nation has abundant energy resources, and these make the U.S. strong.

A perfect example of how these resources can benefit a nation is the U.K.’s discovery of coal, which helped the nation lead the industrial revolution in the 1800s.

As America depends more on its own sources of energy and natural gas and grows less reliant on foreign ones, this shift will help the U.S. remain the preeminent world power. The nation’s transition toward being self-reliant in terms of energy has changed the country’s infrastructure needs.

Six years ago, before the shale revolution took place, we were building LNG (liquefied natural gas) import facilities. These are now being converted to export facilities! This is because MLPs have invested heavily in energy infrastructure to take advantage of the abundant supplies of natural gas the U.S. has unlocked over the last eight years.

This buildup of infrastructure has benefited investors in MLPs, and currently, they can get a 6 percent yield from MLPs with distributions that should rise between 6 and 7 percent this year. Generally speaking, many of these partnerships are undervalued, which provides a strong growth opportunity as the MLP Alerian index is down 20% from its high.

At DeWitt, we are looking to select the best MLPs for our clients, not just buy into a passive index. All the tax benefits of direct ownership of MLPs is preserved with our strategy along with the potential of out-performance. For more information, please don’t hesitate to call or email us.