The Alerian MLP Index’s 406 percent return since late 2008 is a once-in-a-generation gain. Enterprise Products Partners LP (NYSE: EPD), the largest MLP by market capitalization, has enriched its unitholders to the tune of 560 percent over the same period.
But with a distribution yield of 3.6 percent, Enterprise Products Partners’ price moves resemble a momentum stock more than a stable income investment. The same goes for other high flyers like Magellan Midstream Partners LP (NYSE: MMP), which yields barely 3 percent after returning almost 900 percent since late 2008.
Investors shouldn’t buy a security class based on its previous returns—nor should they dismiss it outright.
The key to outperformance is to understand the upside catalysts for a specific sector or industry and focus on the best individual growth stories.
Unlike pundits who have cornered the market on uninformed opinions, my colleague Elliott Gue and I have covered MLPs for over a decade and we track every energy-focused name in Energy & Income Advisor’s MLP Ratings table.
Here are five reasons that MLPs still offer outstanding opportunities for savvy investors.
Despite what you may have heard, the best MLPs should continue benefit from the US shale oil and gas boom, as surging production drives demand for supporting infrastructure to process these hydrocarbons and transport them to end-markets in the US and abroad.
Let’s start with the more than $600 billion in new infrastructure that will be needed to support growing US hydrocarbon production over the next decade.
And the potential upside could be even bigger if Schlumberger (NYSE: SLB) and other oil-field services firms manage to increase the recovery rates on shale oil wells, which today hover around 5 percent.
The universe of publicly traded partnerships continues to swell, giving investors unprecedented options and creating more opportunity for differentiated returns.
The July issues of Energy & Income Advisor dug into recent and forthcoming initial public offerings of new MLPs; subscribers should check out The MLP IPO Class of 2014, Part 1 and Part 2 for our picks and pans from the latest debutants. And there are more to come.
Within the pipeline of prospective publicly traded partnerships, Shell Midstream Partners LP (NYSE: SHLX) shows particular promise and stands to benefit from an extensive pipeline of potential drop-down transactions from its parent, energy giant Royal Dutch Shell (LSE: RDSA, RDS B; NYSE: RDS A, RDS B).
Given the elevated valuations for well-positioned midstream assets, we wouldn’t be surprised if other integrated oil companies opted to monetize some of their North American pipelines, either by selling them to existing partnerships or spinning off their own.
Investment taxes have increased significantly since late 2008. Not only has the top tax rate on dividends and capital gains jumped to 20 percent, but also investors in higher income brackets face a 3.8 percent surcharge on dividends and capital gains to help fund the Obama administration’s health care reform.
Investors looking for legal tax shelters have few options. Detroit’s high-profile bankruptcy and local governments’ tenuous financial positions underscore the risks associated with municipal bonds—a security class that traditionally has been viewed as a safe tax haven. Moreover, the paltry yields offered by municipal bonds off scant compensation for these risks.
In this low-yield environment, the tax-deferring powers of MLPs become more compelling than ever.
And despite fear-mongering about potential changes to MLPs’ tax status, the odds of the government revoking or modifying the tax treatment of these entities remains low.
Not only do MLPs enjoy support for their tax status on both sides of the aisle, but also the revenue that the government would gain by pulling the rug out from under these names remains paltry.
Consider that the Alerian MLP Index’s total market capitalization is less than $300 billion, compared to Exxon Mobil Corp’s $400 billion market cap.
History also appears to be on MLPs’ side. When Finance Minister Jim Flaherty announced the end of Canadian income trust’s favorable tax status on Oct. 31, 2006, these securities represented a whopping 20 percent of the Toronto Stock Exchange’s market capitalization.
And from a practical perspective, we don’t expect the government to pursue a policy that could curtail investment in the infrastructure needed to support the shale oil and gas boom.
In mid-August, Kinder Morgan Inc. (NYSE: KMI) announced plans to absorb the two MLPs under its purview: Kinder Morgan Energy Partners LP (NYSE: KMP) and El Paso Pipeline Partners LP (NYSE: EPB). This transaction resulted in windfall gains for unitholders.
This transaction effectively lowers the Kinder Morgan family’s cost of capital and gives the company more firepower for accretive acquisitions of other MLPs. In particular, Markwest Energy Partners LP (NYSE: MWE) and Targa Resources Corp (NYSE: TRGP) would fit well with Kinder Morgan’s existing assets. (See More Thoughts on the Kinder Morgan Mega Deal and Its Implications.)
We expect more consolidation in the MLP space, as operators look to add scale, fill gaps in their asset portfolios and build strategically for the future. Other transactions will involve private-equity or C corporations acquiring weaker MLPs as a means to monetize their assets. (See MLP Takeover Talk.)
Fears of rising interest rates will spark occasional selloffs in the MLP space, as unsophisticated investors mistakenly assume that inflation will undercut the value of their distributions.
But given the group’s growth prospects, this concern appears to be unfounded.
And consider that when the yield on the 10-year Treasury note surged by 72.3 percent last year, the Alerian MLP Index still delivered a 27.6 percent return.
MLPs are equities, not bonds. These stocks tend to do track the broader market and economy—not interest rates. Take advantage of investors’ irrational fear of rising interest rates and buy our favorites on the dips.
Where are the best opportunities in MLPs space? We’re focused on several areas:
These are the opportunities that are on our radar today. By staying flexible and digging deep into individual companies and sectors, we’ll be able to spot the emerging opportunities and exit stale ones.