MLPs declined 5.3% this week and this index is now down 15.6% in two weeks. The equal weight version of the index declined 6.8%, indicating relative weakness for smaller MLPs. The S&P 500 declined 3.8% and is negative for the year so far. Oil and natural gas prices were weak. The high yield debt market deteriorated.
MLPs were hammered Monday, but managed to gain back all of its losses with strong rallies Tuesday and Wednesday on what appeared to be short covering. MLPs then declined Thursday and Friday as oil prices and credit markets crushed hopes of follow through.
Since peaking on 8/31/14, the MLP Index has produced total returns of -49.0%. The price index has not been this low since October 2009, and the total return index is at its lowest point since August 2011. The index now yields 9.85%, its highest yield since 4/24/09, just when MLPs began to recover from the global financial crisis.
Last week was the 5th worst week for the index of all time, and this week was the 22nd worst week. It was the third time ever that the index has declined 5%+ in two straight weeks. The other two times happened in October and November 2008.
Kinder Lays Down Cover Fire
Last week, I suggested it would be better for the MLP industry if KMI figured out a way not to cut dividends, restoring confidence in the high payout model that made Rich Kinder wealthy. Well, KMI did cut, and it turned out to be a positive for the MLP sector, at least initially. While the KMI collapse the last few weeks was certainly detrimental to the MLP sector, it may also provide cover for MLPs to reduce distribution growth expectations and reduce growth plans without further retribution.
Slow Down to Stop Going Down
Sometimes the best way to avoid losing is to not play. MLPs have been feeling like Clark Griswold in Vegas Vacation, when he continues to lose in an increasingly manic way at casino tables, eventually bottoming out playing silly table games like “Pick a Number” or “Coin Toss”. The frustration for MLP management teams was evident at the conference I attended this week. No matter what news they put out there, they lose. The market has lost confidence in MLPs and is pricing MLPs for inability to access capital at a reasonable cost leading to distribution cuts (or worse).
MLPs are caught in a broken circular reference of returns on growth capital being impacted by financing costs. As the cost of equity goes higher, investing capital and expecting to fund that capex with increasingly expensive capital destroys value rather than create it. The only reasonable way out of such a circle is to defer capital spending, defer financing, and defer distribution growth. Avoid playing altogether, until the odds are more in your favor. Don’t aggressively grow distributions, don’t aggressively add leverage. Find ways to defer capital projects, seek sponsor support in the form of IDR waivers or other support. The market is giving MLPs a pass to get their houses in order, and the sooner they use that pass, the sooner MLPs can start to recover even if oil prices do stay low throughout 2016.
A message from management teams that they will be good stewards of capital is the signal that can turn sentiment around, turn the broken cycle back into a virtuous one, and bolster the MLP sector.
Some of the management teams I saw this week were already doing this, while others have been forced to do so by humbling stock prices. It’s clear that oil prices will not save the sector any time soon. But if MLPs can prove sustainability in a $40/bbl oil environment, then when oil does start to move higher, the sector can grow again off of a healthier base.
Winners & Losers
In a week where the AMZ was down over 5%, the top five were all positive and generated returns above 5%. CPPL was the top performer on no company news while EQM rallied after announcing 2016 guidance on Monday. The bottom five was largely represented by upstream MLPs with the exception of NGL, which was unable to escape the bottom despite reiterating the stability of the distribution and funding plans for projects on Friday.
Year-to-date with the AMZ down over 40%, only four MLPs have generated positive returns with four of the five being refinery logistics MLPs. PBFX cracks the top-five replacing DKL while LGCY replaced FELP in the bottom five.
General Partner Holdings Companies
Only one GP generated positive returns this week and on average GPs underperformed LPs. EQGP, like EQM performed well after announcing initial 2016 guidance.
News of the (MLP) World
KMI’s distribution dominated the news like no other midstream story has ever before. For MLPs, the news was naturally focused on sustainability of current distributions, sponsor support, and private equity stepping up. Some of those worked out, some only briefly stemmed the tide of selling. On the periphery as oil prices declined further, congress appears to be closer to passing legislation that will include a repeal of the oil export ban. Many doubt it will have much impact on price, but it couldn’t hurt at this point, right?