There is growing concern among investors following the MLP sector that today’s low energy prices are indicative of a much larger trend. Depending on the interpretation of the market, investors either view the MLP sector as the best of times or the worst of times due to recent volatility. However, despite collapses in crude oil and natural gas prices, the fundamental of MLPs are not nearly what the market has indicated in recent months.
Market volatility creates a buyer’s market
Many investors think energy prices have much further to go before they hit bottom. With oil prices falling 44 percent and natural gas prices dropping 37 percent since June 2014, several valuations for MLPs have crashed with it. This has scared many investors out of the sector, but according to Jerry Swank, managing partner, founder and portfolio manager of Cushing Asset Management, the market has hit bottom and now is the time investors should make their way back in.
“Today we are nervous, but we would say we have seen the bottom,” Swank explained. “The fundamentals are not nearly what the market has been telling us in the last few weeks.”
Swank noted that plus fundamentals and a bear market make MLPs a premium investment right now.
Yield plays in the MLP sector
As of June 30, midstream MLP yields were listed at 6.4 percent, compared to 2.4 percent for 10-year Treasuries and 4 percent for utilities and real estate investment trusts. A primary example of midstream success recently was Cushing’s MainStay funds that produced 12-month yields at 13.8 percent for upstream funds, 7 percent for midstream funds and 2.7 percent for downstream funds. However, Swank emphasized that although upstream MLPs have the potential for high yields and distributions, they are exposed to more price volatility because they track exploration and production companies. Midstream MLPs, on the other hand, track transportation and storage companies, which has enabled them to maintain their yields and distributions over time.
Investors favor midstream MLPs
The fallen prices of MLPs in the midstream sector have produced market irrationality. With Q2 earnings in line with expectations going into 2015, energy experts are confused over the pessimism of midstream MLPs on Wall Street. Swank noted that as new pipeline and transportation projects continue to grow with more cap-ex invested into the sector, the midstream MLP market is performing as expected.
“These are great stocks that are down 30%, and there’s been no change [in how they do business],” Swank commented. “They continue to stage IPOs, for instance, and do mergers and acquisitions.”
Therefore, with fundamentals intact and distribution growth expected for the next three years, current market valuations for strong MLPs are coming at discounted prices. Midstream MLPs in particular should bounce back as they have done in the past because demand for oil and natural gas are persistent enough that prices will stabilize and begin to rise. So while there is limited short-term volatility in the sector, midstream MLPs have a long-term horizon with significant upside.