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Portfolio Update

The Discipline of Steel

By Roger S. Conrad, on Nov. 9, 2017

Entergy Corp (NYSE: ETR) increased its quarterly dividend by 2.3 percent, the same growth rate as the past two years. Operating earnings per share ticked up 1.7 percent from year-ago levels, as mild temperatures resulted in a 10.1 percent revenue hit at its regulated operations. Excluding weather-related effects, the utility’s sales increased 3.5 percent, led by a 4 percent increase in revenue from industrial customers.

Meanwhile, the company’s wholesale units posted a 136 percent increase on operating earnings, fueled by last year’s sale of the money-losing James A. FitzPatrick nuclear power plant to Exelon Corp (NYSE: EXC) and an improvement in capacity prices. Entergy’s fleet of merchant nuclear power plants also operated at a 98 percent utilization rate, up from 90 percent a year ago.

Management reiterated its guidance for operating earnings to range between $6.80 and $7.40 per share this year. At the Edison Electric Institute’s financial conference, management highlighted plans to accelerate the rate of dividend growth as the company winds down its wholesale operations and expands its rate base. Nevertheless, the stock continues to trade at a discount to its peers. We have boosted our buy target on Entergy Corp.

Painful Medicine

At the height of the shale oil and gas revolution, midstream master limited partnerships (MLP) benefited from robust demand for critical infrastructure to handle the upsurge in onshore hydrocarbon production. Flush with liquidity and growth opportunities, some operators took on excessive leverage to finance projects and pushed the envelope on distribution growth.

But the rash of payout cuts by heavyweights like Kinder Morgan (NYSE: KMI), Energy Transfer Partners LP (NYSE: ETP), Plains All-American Pipeline LP (NYSE: PAA) and Williams Partners LP (NYSE: WPZ) have inflicted severe reputational damage on the industry and scaring away many income-seeking investors.

The inflated multiple that Plains All-American Pipeline paid to eliminate its incentive distribution rights before announcing a second payout cut left a bad taste in many investors’ mouths, while the unwelcome tax bills that unitholders incurred when Kinder Morgan acquired Kinder Morgan Energy Partners a “simplification” transaction didn’t help.

And let’s not forget about Energy Transfer Partners’ perverse willingness to dilute existing unitholders by issuing equity like candy when the stock yielded more than 10 percent. Moves like this serve as a reminder that some management teams view the distribution as flexible and discretionary, especially relative to the fixed coupons on bonds. In the case of Energy Transfer Partners, why not flood the market with equity when your net debt stands at 10.6 times operating cash flow and a sharp distribution cut is inevitable?

With investor confidence in MLPs at low ebb, inflows to the group have slowed significantly, reducing the market’s capacity to absorb equity issuance. Many debt-constrained MLPs with higher yields have responded to this challenge by pursuing private placements of preferred units to finance growth projects or asset drop-downs.

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