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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: MLPs Less Travelled

Midstream basically kept pace with the broader market this week, while MLPs underperformed, again.  Oil prices and broader equities were supportive, but that wasn’t enough to get MLPs moving ahead of EPD results Monday to kick off the meat of 3Q reporting season.

Two Roads Diverged in a Wood…MLP One Less Travelled

The skew in performance between MLPs and the rest of midstream has blown out to its widest point of the last few years at more than 1450 basis points year-over year, with most of the divergence occurring since the end of July.  The answer to MLP apathy could be a strong 3Q reporting season coupled with firming commodity prices.  But MLP-specific outperformance would require they overcome seasonal and secular headwinds to MLP fund flows.

Revisiting Fund Flows One More Time, Again…

The divergence in returns of the above benchmarks is the result of many factors, including disparity of asset quality between corporations and MLPs (more gas pipelines in corporation group), broader investor base able to buy corporations, investors also preferring not to buy MLPs due to governance or tax issues.  Aside form those issues, frustration and impatience among existing owners of the group resulting in fund flows away from midstream overall.

See the below chart for a summary of flows into MLP and midstream vehicles, including ETFs, ETNs, open end mutual funds and closed end funds.  The data is per Bloomberg.  Over the last 12 months through the end of September, the total outflows have been approximately $1.7bn, with a breakdown as follows:

  • Open-End Mutual Funds: $1.9bn net outflow
  • Exchange Traded Notes: $264mm net outflow (dominated by MLPI outflows)
  • Exchange Traded Funds: $429mm net inflow (dominated by AMLP inflows)

Most of those negative flows happened in 4Q last year (YTD total net outflows are “only” around $500mm). 

Two primary takeaways from the above data:

  • AMLP continues to see positive flows and appears to still be the go-to proxy for getting midstream exposure
    • AMLP tracks an MLP-only index that is increasingly concentrated and has much less exposure to traditional stable natural gas pipeline assets, as discussed here ad nauseum
  • The outflows from open-end funds structured as corporations will continue (ex-AMLP apparently)
    • Open end funds structured as corporations were very popular in the early 2010s as an easy way to get MLP exposure
    • The corporation adds an extra layer of tax when compared with traditional Registered Investment Company structures that can own 25% MLPs

AMLP continuing to attract flows is stunning.  It may be explained away as relating to the mechanics of new units being created to match short interest.  But I suspect more of it is laziness and just assuming AMLP is a reasonable proxy for midstream exposure.  To be clear, AMLP is not a reasonable proxy for midstream exposure.  Advisors and consultants who choose that easy but poorly constructed and inefficient ETF do a disservice to their clients.

The midstream universe has structurally changed such that you can’t rely on AMLP to give you a good enough approximation of the midstream universe return.   The AMLP still has cache in the market (and still has more than $8bn of scale), but the returns stream is a shell of its former self. 

Reaching for the AMLP and expecting it to work how it once did is akin to the Washington Redskins signing Adrian Peterson or any other high-profile players (like Donavan McNabb) who have proven to be well past their prime upon arrival in DC.

Reaching for AMLP one more time to get comprehensive midstream exposure and instead getting much worse results than the universe is similar to the trope in film where a powerful character is challenged and calls on his posse to back him, only to find his crew unwilling to continue to support the powerful character, leading to a change in the power dynamic.  It happened to the coach in Varsity Blues, it happened to Alonzo Harris (Denzel Washington) at the end of Training Day.

Reaching for AMLP and expecting it to “work” as originally designed is similar to how each year around Halloween I assume all three of my kids will be excited to dress up and go trick or treating, but then am faced by the harsh reality of waning enthusiasm among the older ones.  Happy Halloween, Fam.

Winners & Losers

Two small MLPs registered double digit returns this week followed by USDP, each trading up after announcing quarterly distributions this week.  DCP was positive on stronger commodity prices and held up even as one of its two sponsors announced a $900mm write down of its interests in DCP on Friday.

PAA and MMP were both in the bottom 5, reflecting deteriorating sentiment on Permian oil pipeline operators.  ENBL’s COO change combined with deteriorating outlook for Oklahoma production (see ENLC below) landed it near the bottom this week as well.

TGP and DCP bounced back from the bottom 5 last week into the top 5 this week.   On the YTD leaderboard, USAC broke above 50% total return, and TGP and PSXP broke 40% total return. 

Midstream Corporations

Median returns for U.S. midstream corporations beat MLPs this week.  Permian G&P names (ALTM and TRGP) led the group this week.  Large cap, widely-held OKE and KMI were among the winners.  The worst performer was ENLC again and PAGP (like PAA above) was near the bottom.

ENLC and TGE repeated in the bottom 5.  TGE reports results this week, with many expecting an update on the strategic situation after the sponsor’s bid in September.  On the YTD leaderboard, OKE took over the top overall spot from KMI and WMB returned to double digit returns.

Canadian Midstream

Gibson led the Canadian midstream group this week, followed by Enbridge.  GEI action seemed to be at least in part due to the election outcome that raised uncertainty as to the future of the Trans Mountain Expansion project, because GEI would likely benefit from demand for storage in the event the pipeline takes longer than expected to be completed.  Likewise, ENB seemed to trade better than the group on the election result, which might buy them additional time to work out contracted rates on their Mainline oil pipeline.

GEI was the best performer last week as well.  On the YTD leaderboard, TRP remains on top, but ENB continues to make up ground on the rest of the group.

News of the (Midstream) World

News flow again this week saw utilities involved in strategic midstream transactions, rather news from midstream companies.  That should change next week, with updates on many strategic processes pending, including two who report next week: TGE and MPLX.

Capital Markets

  • None.

Growth Projects / M&A

  • Dominion (D) announced the sale of a 25% interest in Cover Point to Brookfield for cash consideration of $2bn, excluding working capital (press release)
    • The transaction represents an implied enterprise value of $8.22bn and an estimated 12x EBITDA
  • Mountain Valley Pipeline increased its capex estimate to $5.3-5.5bn from $4.8-5.0bn and delayed the in-service date to late-2020 from mid-2020 (press release)
    • $2.6bn net to EQM, up from $2.4bn

Other

  • Enable Midstream (ENBL) announced departure of COO Craig Harris who is leaving for a CEO role at a privately-held midstream energy company (press release)
    • Harris will serve until November 1, after which ENBL will begin a search for a replacement

Distribution / Dividend Announcements

  • 25 distribution announcements this week
    • EQM and ETRN stop distribution/dividend growth this quarter, will maintain current levels through the in-service date of Mountain Valley Pipeline, will re-assess after
    • DKL and CELP announced distributions late Friday afternoon and are not in the chart below.
      • Bold strategy by DKL to accelerate distribution growth despite double digit yield, high IDR take and rising leverage