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May 26, 2011

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MLP Conference: Sentiment Positive (as Always)

The most important thing to remember about what you hear anywhere: the messenger is as important is the message.  This is definitely important to remember at the MLP conference, be wary of what research analysts say, be wary of what management says, be wary of what investors say.

For example, at the beginning of the conference, Kevin McCarthy and Dave Schulte gave a presentation on the state of the MLP space.  Kevin opened and indicated that the correction since the all time high on April 28th, was nothing to worry about, and that MLPs were cheap on a spread to treasury basis and should be bought at these levels.  He offered 3 reasons for the poor performance in the past month: weak performance of energy sector overall, sector-wide scare over tax changes, and seasonal dividend capture strategies (buying and selling around distribution ex-dates).

Sidenote: I personally don’t think MLPs are objectively cheap, even if yields are relatively cheap.  EBITDA and Distributable Cash Flow multiples are higher than normal. Also, if you take a simplistic distribution discount model, assuming expected growth rates, and a constant yield exit value, and a 10% required return, there are only about 5 MLPs that are cheap at today’s valuations.

So, you have to take what Kevin says with a grain of salt.  He runs the largest dedicated MLP asset management company, which includes several closed end funds that are mandated long-only in MLPs.  He’s “all-in” on the sector and has been for more than 20 years.  I’m not sure what the circumstance would be where he would not be bullish on the sector.  So, you have to remember that when you hear his calming rationalizing words.

Late last night, I did have the chance to talk with Dave Schulte (whose Tortoise Capital manages almost $7 billion, mostly invested in MLPs, mostly long only), and I asked him if given his position he was obligated to be a perma-bull on MLPs.  His response was twofold.  First of all, in general he feels that the opportunity cost of not owning MLPs is too high right now to sit on the side lines and play market timing games, in other words what would you own other than MLPs right now that offers the same yield and growth?

Second, and more relevant and important I think, Dave said that there are more aggressive investments you can make in MLPs and more conservative ones, so if things are toppy, you can be tactical in your allocation to position yourself to outperform.  I agree with this, and the growth in the various asset types withing the MLP sector makes that possible these days.  Tactical allocation and portfolio adjustment has been the key to my returns in the last few years and is where the opportunity exists within the sector currently as the sector-wide yield compression play is over.

More MLP conference thoughts to come, including discussion on the future of PIPEs and general mood of the sector.  In general, the mood is very positive from management teams (but when is that not the case?), the mood is complacent on the banker side (although some bankers are worried that some golden gooses might be less significant going forward like EPD, with fewer entities to do deals for), and the investor mood angry in some cases (like with NRGY and BWP around recent underperformance), but mostly good.

The least bullish guys I talked to at the conference were two former colleagues and current investment bankers, both still smarting from the Lehman Brothers blow up and prior MLP blowups, but at least someone remembers the downside…

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