At a time when Treasury yields have been nonexistent, MLP investors have been able to get high payouts that are viewed as quasi-dividends, due to some payouts representing income and some representing return of capital. The question to ask now is whether the risk-reward is there for new investors at the current prices. The unit prices of many key MLPs have been hit hard along with stocks in the past few weeks, and we wanted to take a risk-reward look for summer 2012. This sector could get a recovery, or it could face additional pressure like we saw in 2011.

If investors have been involved in the MLP sector since before, during or right after the great panic selling of 2008 and 2009, they are up huge if they held on. In many cases they have doubled their money or more. And as far as they are concerned they have been getting 5% to 8% in payouts each year (again, some income and some return of capital). The problem is that the prices here have become choppy and the MLP structures often have had secondary offerings on top of secondary offerings. Those secondary offerings have provided growth and acquisition capital, but some investors have started to worry that these secondary offerings may be the biggest contribution to the never-ending payout increases that have been seen in this sector.

MLPs in the energy space often attract the same sort of investors who would buy utility shares and preferred shares of banks, but they also overlap with REIT investors who look for above-market yields. This sector has enjoyed large price gains in the unit (share) prices, and investors are looking for any safe investments that have high payouts, compared to the world of no-returns in CDs and Treasuries. A wave of secondary offerings from many MLPs came before and during the recent market sell-off.

24/7 Wall St. has evaluated some of the top MLP investments to see how much implied upside remains in this sector. We have taken price performance as far as the sell-off from recent highs, as well as issues like the payout ratios (implied yield-equivalent) and the consensus price targets from Thomson Reuters. We have evaluated the following MLPs: Enterprise Products Partners LP (NYSE: EPD), Kinder Morgan Energy Partners LP (NYSE: KMP), Plains All American Pipeline LP (NYSE: PAA), ONEOK Partners LP (NYSE: OKS), Energy Transfer Partners LP (NYSE: ETP) and Enbridge Energy Partners LP (NYSE: EEP). These MLPs mentioned and covered here are some of the ones we track and keep on our watch list in the sector. These have market caps above $8 billion, they have a history of increased payouts each quarter, for the most part, and generally speaking these MLPs are all believed to have good management teams.

Investors have made a bundle here in this sector. MLPs are not really all that correlated to the price of oil because these are the partnerships (general and limited) for pipelines, terminals, and other facilities involved in the oil and gas sector in America. MLPs must derive 90% of their income from real estate, natural resources and commodities. The issuing of K-1 statements can make the structure more complicated, but the payouts often make that worth it for many investors seeking higher streams of cash flow.

We also have evaluated some of the key ETFs and closed-end funds in this sector. Be advise that just the three vehicles we have tracked in funds and ETFs have a combined market value of more than $11 billion.

The original capacity of the pipeline will be 150,000 barrels/day, with expansion planned to exceed 400,000 barrels/day by the first part of next year. If a “loop” or second, parallel pipeline is added, the total capacity of Seaway will reach 850,000 barrels/day by 2014. The Seaway pipeline is one of several proposed crude oil pipelines that would carry crude from North Dakota, Montana, and Alberta to the US Gulf Coast, where crude prices are higher.

Transcanada Corp. (NYSE: TRP) has filed a new proposal for its Keystone XL pipeline, while Oneok Inc. (NYSE: OKE) and Oneok Partners LP (NYSE: OKS) have proposed a 1,300 mile route from North Dakota to Cushing, while Enbridge Energy Partners LP (NYSE: EEP) and parent Enbridge are proposing new and reversed pipelines to move crude to Cushing.

Crude from the Bakken oil play and the Canadian oil sands sells at a steep discount to Brent crude, which sets the price benchmark on the Gulf Coast. Producers hope to boost the price they get for their crude if they can just get the black stuff to more liquid market. For consumers, closing the price differential will very likely mean higher prices.

Paul Ausick

Oneok Partners is 43.5% owned by Oneok Inc. (NYSE: OKE), which also owns the general partner interest in Oneok Partners. Both companies have been focused on natural gas transportation and production and this marks their first foray into the crude oil transportation business.

A competing pipeline, proposed by Canada’s Enbridge Energy Partners LP (NYSE: EEP) and parent Enbridge Inc. (NYSE: ENB), would move the oil directly east out of the Bakken or north into Saskatchewan before being sent to eastern Canada or Chicago.

Neither of these plans is as grand as the 1,700-mile, 1.1 million barrel/day TransCanada Corp. (NYSE: TRP) proposal for the Keystone XL pipeline. However both follow existing rights of way and neither transports oil from Canada into the US, a major sticking point on the Keystone XL project. And the Oneok plan is the first major US pipeline to plan on hauling a substantial amount of Bakken crude to the major US trading hub.

A large map showing the route of the Oneok Partners’ Bakken Crude Express Pipeline is available here.

Paul Ausick

The “units” have been extremely popular with income-oriented investors as investors look for high cash flow back into their accounts and while still looking for upside participation from the markets.  This morning came a report from Zacks naming Enterprise as the “Bull of the Day” when it raised its rating to Outperform from Neutral. More important than the Zacks upgrade is that it has a $54.00 price target objective and that appears to be a “street high” target.

As far as how this compares to analyst calls elsewhere: BofA/Merrill Lynch has a “Buy” rating with a $50.00 target, Morningstar has a “Hold” rating, and S&P has a “Buy” rating.  Thomson Reuters has a $48.40 consensus price target, almost 10% above the $44.13 close on Wednesday.

Here are ten things we have considered…

Chesapeake Energy Corporation (NYSE: CHK) recently announced that it reached an agreement to supply Enterprise with ethane for its proposed pipeline that connects the Marcellus Shale with the Gulf Coast.

The integration of Duncan Energy Partners LP should be beneficial for the partnership and unit holders.  The partnership with Enbridge Energy Partners LP (NYSE: EEP) and Anadarko Petroleum Corporation (NYSE: APC) for building a pipeline called the Texas Express should address transport constraints in place today on the Gulf Coast NGL market.

It is a heavy-weight in the sector with its $37 billion market cap.  The JPMorgan Alerian MLP Index ETN (NYSE: AMJ) lists that Enterprise is the largest single holding in its underlying index with a weighting of almost 15.8%. Kayne Anderson MLP Investment Company (NYSE:KYN), a closed-end MLP fund, also has Enterprise as its highest weighting at 9.4% in its latest report.

Besides being a leader above many peers, its projects tend to generate stable cash flow and they tend to add to the value in the company’s existing portfolio.

The company’s opportunity in the Eagle Ford and Haynesville Acadian Expansion should be great long-term catalysts.  Here is its existing pipeline and facilities system-wide map.

The company increased its quarterly distribution for the umpteenth time in a row and its dividend equivalent is currently over 5.5%. 

Distributable cash flow was $856 million with a coverage ratio of 1.7, and the $341 million in retained cash flow has seemingly lowered its financing needs.

The most recent earnings report was a record for the third quarter in part due to growth in the shale regions and high demand for NGLs in the petrochemical sector.  Earnings per unit were $0.55 (above a $0.50 target from Zacks) and up over 200% from a year earlier.
Revenues was up 40% from a year earlier.

Operating income in the NGL pipeline & services unit was up over 37% and gross operating income in its nat-gas processing segment rose 55%.  Its gross operating income from onshore crude pipelines and services were up over 90% from a year earlier.

The area of contraction was the Offshore Pipelines & Services on the gross operating income, which came down to $53.9 million versus $68.3 million a year earlier, on what was called lower Gulf of Mexico exploration and development on federal regulations.

There are many other things to consider for Enterprise (and other MLPs) for longer term income-oriented investors.  Investors in MLPs in general have to consider the tax ramifications as many quarterly payouts have to be considered “yield equivalent” rather than true income because a large portion of the payouts in the MLP sector are treated as return of capital with a variable portion often treated as income.  Barron’s noted it in the “Top MLPs for Investors” but we would note that Seeking Alpha recently raised a flag of caution on the group and on Enterprise itself.  We like to feature both good and bad when possible.

JON C. OGG

As for the use of funds, the “use of proceeds” indicated funding a portion of its capital expansion projects, for general corporate purposes, or any combination of such purposes.

Morgan Stanley, BofA Merrill Lynch, Citigroup, J.P. Morgan, UBS, and Wells Fargo are listed as the joint book-running managers for the offering.  The underwriters have been granted a 30-day option to purchase up to an additional 1.2 million units to cover any over-allotments.

The selling is coming along with the market this morning, but the selling is deeper and wider than the buyers are getting.  The $28.20 per unit price compares to a $27.50 price indication this morning.  The partnership closed at $29.09 yesterday and shares were above $29.50 at one point yesterday.

The $218 million size compares to a market cap of $7.44 billion based upon yesterday’s close.  In short, 3% dilution is against more than a 5.3% drop in the price.

JON C. OGG

The Partnership gave a “use of proceeds” as being to repay a portion of its outstanding commercial paper, to repay any credit facility borrowings, to fund a portion of capital expansion projects, or any combination of such purposes.

This partnership owns and operates crude oil and liquid petroleum transportation and storage assets.  It also owns and operates natural gas gathering, treating, processing, transmission, and marketing assets and is based in Houston, Texas.

The offering group is rather large.  The listed underwriters for the offering are listed as BofA Merrill Lynch, Wells Fargo Securities, Citigroup, Morgan Stanley, and RBC Capital Markets.  The partnership is expected to grant the underwriters a 30-day option to purchase up to an additional 1.05 million units to cover overallotments.  If so, more than 8 million units will be sold.

Shares are down over 3% at $30.01 and the 52-week trading range is $25.19 to $34.58. On a split-adjusted basis, that 52-week high represents an all-time high as well.   This also offers a high “dividend equivalent” with a payout of about 6.7%.

JON C. OGG

The partnership said that the net proceeds will be used to repay a portion of its outstanding commercial paper and any credit facility borrowings which had been used to finance a portion of its acquisition of the entities that comprise the Elk City Gathering and Processing System.  The partnership also noted that it will use a portion of the proceeds to fund a portion of its capital expansion projects.

The joint book-runners are Morgan Stanley, BofA Merrill Lynch, J.P. Morgan, RBC Capital Markets, UBS Investment Bank and Wells Fargo.  Enbridge Partners has also granted the underwriters a 30-day option to purchase up to an additional 780,000 units to cover any over-allotments, if any.

Enbridge Energy Partners LP is down over 3% at $60.12 shortly before the open and the 52-week trading range is $38.02 to $63.39.  The $300 million compares to a market cap at yesterday’s close of roughly $7.4 billion.

JON C. OGG

The ruptured pipeline, part of Enbridge’s Lakehead system, consists of about 293 miles of 30-inch steel pipeline that was first put into service in 1969. The line transports crude oil from northwest Indiana to Sarnia, Ontario, just across the US-Canada border at the southern tip of Lake Huron.

The pipeline had been checked for corrosion in June 2009, using a device called a ‘smart pig’, which is inserted into the line and creeps along using ultrasonic and other technology to check for weaknesses in the pipe. Enbridge notified the US Pipeline and Hazardous Materials Safety Administration (PHMSA) on July 15th that the company planned to remediate anomalies in the line by replacing rather than repairing the pipe, but that the effort would require more time than Enbridge had been given. The pipeline ruptured on July 26th.

The damaged section of pipeline has now been removed and shipped to Washington for further examination. Here’s a photo of the damaged section.

The damage appears to be along a seam that runs the length of each 50-foot section of pipe. The hole itself is called a “fish mouth” rupture for obvious reasons. The position of the rupture in the photo is oriented approximately as it was when it was underground, with the rupture at about the 3 o’clock position.

A common cause of ruptured oil and gas pipelines is stress corrosion cracking, where water in the pipeline gathers at the bottom of the pipe and slowly corrodes and weakens the pipe from the inside out. Damage to the coating could also occur when the pipe is transported from the factory to the pipeline site or any of a variety of knocks and dings occurs during construction or service.

Under the pipeline pressure needed to move the oil, stress is added to the corrosive effect, particularly near pump stations like the one at Marshall, Michigan. Pressure in the pipeline at the time of the rupture was estimated to be 425 psig, safely below the rated maximum of 624 psig.

It is highly unlikely that the rupture in the Enbridge pipeline was caused by stress corrosion cracking because that anomaly nearly always occurs at the bottom of a pipe (the 6 o’clock position). In a similar pipeline rupture in Minnesota in 2002 the cause was determined to be a stress fracture that started when the pipeline was loaded onto a truck in 1967 for transport.

The service life of a pipeline is typically judged to be about 30-40 years. In general, periodic inspection of the pipelines leads to sections being replaced piecemeal rather than replacing the pipeline at one time. New pipeline construction costs could total as much as $2 million/mile.

From 1990 through 2009, the US has averaged more than one serious incident on an oil or gas pipeline every week. That totals nearly 1,100 in twenty years. For ‘significant’ incidents on all oil pipelines, the 20-year total is 5,626, or more than five incidents per week. A ‘significant’ incident releases 50 or more barrels of liquid into the environment or costs more than $50,000 in 1984 dollars; a ‘serious’ incident is one in which someone is killed or a hospital stay is required.

As will be the case with offshore drilling, onshore, and offshore, pipelines are sure to come under greater scrutiny after the Gulf of Mexico and Michigan spills. More frequent inspections and a quicker response from the industry to repair deficiencies are the two likeliest outcomes.

Paul Ausick

After reviewing this data, 24/7 created a list of The Twenty Companies Wall St. Can Trust The Most. The firms are ranked based on their Accounting and Governance Risk scores.

The list represents companies that have practices which should be emulated by every public company that wishes to serve the needs of its shareholders by presenting accurate financial data and providing conservative management of shareholder’s investments.

The Twenty Companies Wall St. Can Trust The Most:

Methodology: The Audit Integrity Accounting and Governance Risk (AGR) rating is a forensic measure of the transparency and reliability of a corporation’s financial reporting and governance practices. The focus of AGR analysis is on identifying the measures most highly associated with fraud, and quantifying those risks for interested stakeholders in relation to company stock price, securities litigation, and major restatement probabilities.

Audit Integrity applies over 100 accounting and governance metrics to a company’s publicly-filed information. The resulting calculation produces the AGR, a percentile score ranging from 0 to 100, with corresponding ratings from Very Aggressive to Conservative.

Companies rated Very Aggressive or Aggressive have proven to be much more likely to face class action litigation and financial restatements, and to suffer severe equity loss. Conversely, those companies that have been consistently rated Conservative have been shown to be the most trustworthy.

AGR significantly improves the predictivity of traditional risk models.

The AGR and its underlying metrics are used by regulators, auditors, insurance companies, investment managers, and corporations, and are often incorporated in reporting by major financial media.

Douglas A. McIntyre

Enbridge Inc. (ENB) and Enbridge Energy Partners, L.P. (EEP) had a pipeline blow late yesterday that has oil up as much as $4 today; two workers were killed; the explosion and fire on an Enbridge Energy Partners’ crude oil pipeline approximately three miles southeast of Enbridge’s Clearbrook, Minnesota terminal is apparently one of the Canadian pipelines that comes down to the U.S. and it is a supply risk.
Fred’s (FRED) $0.12 EPS after $0.02 "timing event" versus $0.14 estimate; hired Merrill Lynch to help it review strategic alternatives after receiving interest from multiple parties.
HJHeinz (HNZ) $0.71 EPS vs $0.69 est.; put guidance at higher end of range for next quarter.
Lululemon (LULU) trading up 10% after beating earnings and raising guidance.
Medco Health (MHS) announced a 2 for 1 stock split.
Men’s Wearhouse (MW) trading down 12% after disappointing earnings.
Sigma Designs (SIGM) traded up 14% after posting $0.79 EPS vs $0.54 estimates.
Ultralife Batteries (ULBI) receive a $2.6 million order from the U.S. Defense Department.
VeraSun Energy (VSE) and US BioEnergy (USBE) are going to merge operations into a single company; USBE shares up 8%.
Vimpel-Comm (VIP) trading up 5% after beating earnings expectations.
WellCare Health Plans, Inc. (WCG) traded up 10% after-hours after announcing that on November 21, it received an executed Contract between the Centers for Medicare & Medicaid Services. This one had been battered after that FBI raid killed the stock in recent weeks.

Jon C. Ogg
November 29, 2007