MLP distribution announcement season is almost over, and it has bled into earnings season, which is in full swing this week even amidst the breaking storm clouds around the northeast (Austin sunny and warm, FYI). But with the vast majority of MLPs having announced distributions for the quarter, it’s a good time to review some of the distribution statistics (in between earnings conference calls). Also, in case you were wondering, in October the MLP Index was up 0.5% for the month and has produced 9.0% total return for the year. By comparison, the S&P 500 was down 1.85% in October and has produced 14.3% total return.
Back to distribution growth. There are three directions a distribution announcement can go: up, flat or down. Certain MLPs like to be consistent and get the investment community into a habit of expecting distribution increases. A quick glance at the names on the list of MLPs with the longest distribution growth streaks and it’s clear that growing distributions consistently makes for happy investors.
The second alternative is to keep your distribution flat. Certainly better than cutting your distribution, but a look hard enough at the names on this list, and for the most part you’ll see disappointed investors.
Then there is the third option, cutting your distribution. Usually it starts by cutting distributions to subordinated units first, then if things haven’t improved in a few quarters, the distribution to common gets cut as well. It can be a deep cut (OXF, NRGY) or a smallish one (RNO). This year, 3 MLPs have cut their distributions: NRGY announced a 46.8% distribution cut at the beginning of the year, RNO cut its distribution down to its MQD last quarter (a 7.3% cut), and OXF announced a 54.3% cut earlier this week.
Still no large cap midstream MLP has cut its distribution, but some day it will happen, and we’ve had some close calls so far this year, with BPL and NS in particular under-earning their distributions for several quarters now. Someone asked me what would happen to the rest of the sector if one of those two MLPs cut their distribution. I don’t believe NS will, but in any event, if a larger older MLP cut its distribution, I think they will have been beaten down to such an extent before it happens that the actual event won’t have a knock on effect on other MLPs.
Components of MLP Returns
Below is a chart of the drivers of the returns of the Alerian MLP Index. I saw this chart originally in a Barclays research report by Rick Gross. I’ve updated it, so I can call it my own now, but wanted to disclose where I got it from originally. What it shows is that so far in 2012, more than half of the total returns of the MLP sector have come from the distributions themselves, while just under half have come from distribution growth. The valuation component accounts for the changes in yield over time. Yields on MLPs have risen slightly since the beginning of the year.
The interesting part is looking back 3 years, when valuation played a much larger role than is normal. At the end of 2008, the MLP Index had a yield of more than 12%. That yield dropped to 6.1% as of September 30th. That yield drop drove outsized returns for the MLP index over the last 3 years.
Historically, income has accounted for the bulk of MLP returns, with distribution growth accounting for around 35% to 40% annually. A benign interest rate environment, probably the most benign we’ve ever seen, has certainly helped MLPs yields to come down, driving around 15% to 20% of the annual MLP returns. It seems like interest rates can’t go lower, and while there is room for MLP yields to compress and reduce the spread to those interest rates. But that valuation compression is a fickle thing to bet on. It’s best to bet on income and growth. Finding MLPs that have attractive yields and attractive growth rates is what you bet on, and you hope MLP yields don’t back up such that it overwhelms the other two components of return.
Distribution Growth: Top 20 This Quarter
So, which MLPs are growing distributions the fastest? Quarter over quarter this quarter, TLLP was the winner. Below is the list of the top 20 quarterly distribution growth rates, and their corresponding year over year and 3 year annual growth rates.