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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

DECADENCE TO DECAY: A DECADE OF MLPguy

As of this week, I have now been publishing thoughts on MLPs at MLPguy.com for more than 10 years.  The usual end of the year reflection in the media and among investors will be magnified arbitrarily this year by the end of the decade.  I wanted to get out in front of most of the decade in review pieces with some early reflections on what has changed in the midstream sector in the last 10 years, then stay tuned for a future post that will focus on the next 10 years.

Key Takeaways:

  • MLPs performed well for first 5 years of the last decade, poorly thereafter
  • Number of MLPs and midstream MLPs is the same as it was 10 years ago, but in the interim there were 87 IPOs
    • Massive expansion of the space, followed by a contraction
  • Over the last decade MLP products proliferated with 89 total products launched (including 40 open end mutual funds, 24 closed end funds, 15 ETNs and 10 ETFs)
  • IDRs are much less common today, but IDR eliminations had already begun a decade ago
  • Equity issuance is basically non-existent today, huge divergence from the prevalent external financing model employed by MLPs a decade ago.
  • Midstream development capex has grown in the last decade and remains very high
  • 10 years ago, MLPs were the group with the best cost of capital and were most likely to pay the highest price for midstream assets at auction, due to distribution-based valuations and ready access to equity capital
    • Today, private equity seems to have a lower cost of capital than MLPs, and the market seems to prefer MLPs that do not participate in M&A
  • Fundamentals have shifted from shortage to abundance of all hydrocarbons, which has had large impact on MLPs that previously enjoyed large seasonal spreads in natural gas pricing, and better processing economics
    • Today the focus has shifted to tapping into global demand sources via exports downstream of traditional midstream assets

Further discussion of those above bullets can be found after this large graphic full of numbers from two very different points in time exactly 10 years apart.

High Level Performance Review

First, let’s discuss performance.  The last 10 years included the tail end of the streak of 12 consecutive years of outperformance by MLPs relative to the S&P 500.  That streak ended in 2011, but returns on average from 2010 through 2014 beat the S&P 500.  The last 5 years have included just a single positive year in 2016, when midstream stocks overall (AMNA) outperformed the S&P 500 by a wide margin.

Number of MLPs

Based on my databases of investable energy MLPs in existence (so not including Rio Vista Energy Partners, Stonemor, Landmark, Cedar Fair, etc), I believe there were around 59 total energy MLPs at the end of 2009, including 34 midstream MLPs. 

Since that time there have been 87 MLP IPOs, but I still count 59 remaining energy MLPs today, including 34 midstream ones (numbers include ENLC, RTLR and TGE, which are corporations for tax purposes even though they are eligible for inclusion in the MLP index).  There is a wonderful symmetry to the expansion and contraction of the sector over a 10-year span.

IDR Eliminations

A big change in the midstream sector in the last decade has been the shift in thinking on incentive distribution rights (IDRs).  Newer investors won’t remember this, but in the wake of the financial crisis, 3 publicly-traded general partner holding companies merged with their subsidiary MLPs and eliminated IDRs.  10 years ago, Magellan had already simplified its IDR structure by acquiring MGG.  Buckeye and Enterprise followed in the next two years. So, it was starting back then, but didn’t really pick up until 5 years later when KMI bought its MLPs.

Still, at the end of 2009, there were many more MLPs with IDRs (42) than there are today (18).  Of the 18 MLPs with IDRs still in place today, most are very small MLPs that combine to make up a small piece of the overall MLP market.   

Boom in MLP Products

A trend we saw between 10 years ago and today is the proliferation of MLP products.  As noted above, there were more new MLP/midstream investment products (mutual funds, ETNs, ETFs) created (89) than there were new MLPs created (87).  This has led to greater ownership of MLPs by institutions over time, and a crowding out of individual retail investors that had previously dominated the market.

Now that the number of MLPs trading has dramatically contracted and we are back to the same number of MLPs as 10 years ago, we are seeing a serious unwind of some portion of the institutional capital from those products. 

Equity Issuance No More

Another huge change is the shut down in the equity capital markets today as compared with 5-10 years ago.  MLPs and midstream companies are still spending a lot of capital, but the equity capital markets are not receptive to them financing spending with public equity offerings like they did in the past.  One of the biggest challenges for midstream companies today is proving they can finance such a high level of spending with excess cash flow or through alternative financing (asset sales, joint ventures, etc.).  The market is saying it would prefer they did not spend so much on growth projects.

General Valuation Dynamic

Another huge change is the relative discount MLPs trade at today.  10 years ago, MLPs as a group traded at a premium to corporations because they traded on yield based on very high payout ratios.  That and ready access to capital made MLPs able to offer the highest prices in M&A auctions, outbidding private equity or corporate buyers.  That has flipped today, where MLPs yield 10% and are at a disadvantage relative to private equity and corporations for M&A opportunities.

Fundamentals Have Changed

Fundamentally, there has been a big change in the business of midstream when it comes to processing margins and natural gas storage.  The growth in supply of natural gas and NGLs has collapsed some of the margins that MLPs used to benefit from, which has been a headwind for some over the years.

High School Reunion Movies

All this talk of the last 10 years got me thinking about high school reunion movies, so I’ll finish with a fun GIF that gets to the bittersweet feeling of having written about MLPs on the internet for free for the last 10 years.  The two most notable movies that centered on a 10-year reunion oddly both came out in 1997: “Grosse Pointe Plank” and “Romy and Michele’s High School Reunion”.  

I remember Gross Pointe Blank much more clearly than the other one, and I may still have the DVD somewhere.  It starred John Cusack as a world class assassin (in some kind of guild like John Wick, for you younger readers) who goes back to his home town for his high school reunion after disappearing 10 years earlier.  Other assassins track him there and comic scenarios ensue.  His best friend who hadn’t seen him in 10 years is played by Jeremy Piven, who repeats 10 years a bunch of times as he adjust to seeing his friend again.