More Woes for MLPs Ahead?
Master limited partnerships, or MLPs, have become big business and have become more prevalent in investor portfolios over the past couple of years. They give exposure to the growing oil and gas infrastructure of America, and they come with rather high distributions that attract investors seeking dividend yields and capital flows. The problem is that this business segment of the oil and gas sector has seen its valuations become lofty as investors have chased returns, and now the performance is also coming under question.
The MLP sector’s major bull market run seems to have peaked, and many dividend-oriented investors still seem to not understand what they are buying into when they get these “yields” of 5%, 6% or even much higher. Investors in this class of assets also may not understand what the real risk is in these either. Still, not all is lost, and there are many great entities out there. 24/7 Wall St. wants to highlight what some of these risks are, and what investors can use for measuring risk.
Much of the sector’s woes had already been creeping up, but Boardwalk Pipeline Partners L.P. (NYSE: BWP) seems to have been the catalyst that raised the red flags. 24/7 Wall St. warned investors that this should have been a warning sign for all MLP investors to know exactly what on earth it is that they are investing in. We also recently featured a sector survey of the MLP universe after the Boardwalk implosion.
24/7 Wall St. has another warning to income investors. You might indirectly own MLPs in your portfolio and not even know it. Many energy funds and exchange traded funds (ETFs) own either MLP units or their general partners. Many domestic and global infrastructure funds and ETFs also own MLPs or their general partners. Go look up the holdings for funds with the name “infrastructure” in them, and then you will know why MLPs are generally considered the toll-road model of the energy sector.
And last weekend a Barron’s cover story “Yield of Dreams” focused on the Kinder Morgan entities — Kinder Morgan Energy Partners L.P. (NYSE: KMP), Kinder Morgan Management LLC (NYSE: KMR), Kinder Morgan Inc. (NYSE: KMI) and El Paso Pipeline Partners L.P. (NYSE: EPB). This was a rather unfavorable highlight of what is considered one of the best-managed and the largest combined entities in the sector.
The Barron’s summary simply warned, “With a yield of 6.9%, Kinder Morgan’s MLP is an investor favorite. But with growth slowing, it could lose appeal.” The major target of the Barron’s article was Kinder Morgan Energy Partners, L.P. (NYSE: KMP), and this took more than 5% out of its unit price. Even Kinder Morgan Inc. (NYSE: KMI) fell almost 3% on the article.
Two more MLP red flags should have been noticed a week prior to the Barron’s bash. The first was that Kayne Anderson MLP Investment Co. (NYSE: KYN), a well-run and leading MLP closed-end fund, sold another 8 million shares at $37.05 per share for net proceeds of $285 million — after having previously closed at $38.81. The second flag was that Enbridge Energy Partners L.P. (NYSE: EEP) was challenging its 52-week low at the same time that the market was trying to hit new highs. This MLP managed to close up 1.6% at $27.15 last Friday, but its units hit an annual low of $26.30, versus a 52-week high of $33.49. Its market cap is some $8.7 billion, and its distribution yield is listed as about 8%. Enbridge Inc. (NYSE: ENB) in Canada has approximately 21% of overall ownership in Houston-based Enbridge Energy Partners.
At the end of 2013, the Kayne Anderson fund had some $6.4 billion in total assets. That capital raise by Kayne Anderson was after the fund entered into a $150 million unsecured term loan credit facility in the same week — also with the purpose of making new portfolio investments, paying down debt or for other general corporate purposes. Only about 5.5% of the fund’s assets are in Kinder Morgan Management. Our observation is that when Kayne Anderson raises capital it is almost always around a series of capital raises by the MLP sector. Kayne Anderson also uses some leverage in its investing strategy, and it yields close to 6.6%, based on its most recent dividend payment.
Goldman Sachs MLP Income Opportunity (NYSE: GMZ) is a new closed-end MLP fund, which launched in late 2013 by none other than Goldman Sachs Group Inc. (NYSE: GS). This fund’s launch was followed by additional leverage financing — $826.3 million for the fund’s IPO followed by a $395 million line of credit. This gives the fund an ability for close to 50% leverage, and it feels rather late to the MLP party when you consider how many other alternative investment vehicles there already are in MLPs. The “GMZ” fund’s yield is based only on one single distribution so far, but that screens out at 6.5%.
Investors need to know that the MLP sector’s valuation is generally based on the effective yields, even though these distribution “yields” are composed of both income and a tax-advantaged return of capital component. For years there has been a concern, which has yet to come to fruition, that if longer-term Treasury yields rise handily then MLP investors would lighten up on or exit the sector in favor of safer yields. Another concern has been that Washington D.C.’s quest to raise taxpayer revenues may eliminate at least some of the tax advantages of MLPs.
Back to Boardwalk Pipeline Partners L.P. (NYSE: BWP) for a moment. When units fell from $23.91 to $12.91, and on massive volume of an unheard of 43 million units in one single trading session, close to $3 billion in value disappeared instantly. Let’s just say that for a multibillion dollar MLP to lose about half of its value, after having already lost about one-fourth of its peak value, is not a normal event in this sector.
The big concern for Boardwalk investors — besides the natural gas exposure woes that helped create the turmoil — is the quarterly distribution was slashed to $0.10 per unit. That payout was above $0.53 per unit and had been relatively the same for the past two years.
Another Barron’s warning on Kinder Morgan: “Kinder Morgan’s expansion capital is almost entirely financed with new debt and equity from the MLP, making it vulnerable to higher interest rates and dislocations in the capital markets.” Kinder Morgan Energy Partners L.P. (NYSE: KMP) trades for about $78.50 and yields about 6.9%. It is owned mostly by retail investors, and it raised more than $500 million in a recent unit sale to the public.
Many words of caution were brought up by Barron’s and by outsiders quoted in the report, but one really stood out — that Kinder Morgan Energy Partners L.P. (NYSE: KMP) should be trading at about $60 (versus $78.44). Again, that is their figure. The article did not really concentrate on CEO and Chairman Richard Kinder recently buying shares, nor that he is considered one of the top energy CEOs in America. Still, a 5% drop is a 5% drop to its holders.
JPMorgan Alerian MLP Index ETN (NYSEMKT: AMJ) is one of the top exchange-traded products out there. Be advised that this is technically an exchange-traded note and is considered a senior and unsecured obligation of J.P. Morgan Chase & Co. (NYSE: JPM) rather than a basket of true MLP assets. This one also has a maximum number of units issued and can trade at wider discounts or premiums to the underlying net asset value. In short, some investors may consider this to be a hybrid vehicle that is not quite an ETF and not quite a closed-end fund.
The ALPS Alerian MLP ETF (NYSEMKT: AMLP) is now the MLP benchmark for ETFs. It trades close to 2.8 million shares per day. Some 9% of this ETF is invested in Kinder Morgan Energy Partners L.P. (NYSE: KMP), and it holds many of the other MLPs of concern already mentioned. Its total return performance of 18.5% in 2013 would have been considered stellar in most years, but the S&P 500 was up just shy of 30%.
It should be of very little surprise at all that the MLP sector is under fire. After all, Merrill Lynch started out 2013 being very cautious here and was only optimistic on some of the top names. The sector’s performance has started to lag, and the big and small MLPs keep selling more and more units, which some investors think is how the entities can keep maintaining such a high distribution.
Again, all is not lost in the master limited partnership universe. Some of these companies do not leverage up too much, and some have payouts that are not too aggressive and that can easily be maintained. That being said, it is very important for investors to understand what it is that they are buying.