7 MLP opportunities for investors – James Dondero
Mid-April has seen a consecutive multi-day rise in oil prices, with West Texas Intermediate briefly hovering around $57, its highest level since last December. This comes as the Department of Energy reported declining crude production, along with a small rise in inventories. Additionally, OPEC has predicted a decline in U.S. crude production for the second half of 2015. Escalating global conflict has also given prices a boost.
It’s too soon to say whether this recent upsurge will continue and typically markets take time to digest a steep rout in oil prices. Bears would say there’s more downside in oil prices to come; we feel prices have seen their lows for the year.
But irrespective of oil or gas price movements, we believe specific midstream MLPs that were hit hard along with the broader energy sector might represent a compelling alternative yield product for investors.
As is the case with REITs, not all MLPs are created equally.
Upstream MLPs have rightfully experienced the worst decline along with oil; because they focus on production, they are heavily exposed to the price swings of commodities. As commodity prices have been extremely volatile to the downside, many upstream MLPs have cut distributions.
Midstream MLPs, on the other hand, focus on storage and transportation. They have long-term contracts that are largely fee-based or take-or-pay, often with built-in inflation adjustments. They may not offer yields as high as the upstream MLPs, but they are far less sensitive to commodity prices, and coverage ratios are typically better. Nonetheless, the midstream sector also fell approximately 20% due to the negative sentiment, as investors panicked and sold all related names, regardless of commodity sensitivity.
Seven companies in particular appear to have the greatest potential to experience sizeable price appreciation as the ratio between high quality midstream MLPs and high quality REITs converge. All have experienced some gains as industry insiders recognize the buying opportunity. Investors may also want to consider taking advantage of an unjustly battered sector since the convergence may be far from finished.
Kinder Morgan (KMI) and Enterprise Products Partners (EPD) are two of the largest and most diversified companies in the space, and Plains All American Pipeline (PAA) is one of the largest midstream providers in North America. Given their large established asset footprints and relative yield spreads, all three look particularly compelling right now.
In addition, Energy Transfer Equity (ETE), MarkWest Energy Partners (MWE), Targa Resources (TRGP) and Williams Companies (WMB) look attractive, as they all have underappreciated asset footprints, potential to participate in M&A and/or high perceived commodity price sensitivity.
The return potential of these companies is illustrated in the following graphs, where the current yield spreads of the individual names are compared against their historical average (each versus the high-quality REIT index). 1 These reflect potential returns from spread compression only; company-specific growth or other factors could provide even more upside.
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1 Source: Bloomberg, 12/31/12-4/17/15; REIT Index is comprised of an equal weighted index of the following indices: (1) FTSE NAREIT Industrial/Office Property Sector Index, (2) FTSE NAREIT Retail Property Sector Index, (3) FTSE NAREIT Residential Property Sector Index, (4) FTSE NAREIT Diversified Property Sector Index, (5) FTSE NAREIT Health Care Property Sector Index