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October 25, 2015

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Week Thoughts: MLPs Bell-Weathered

MLPs declined each day this week, finishing down 6.1% overall.  MLPs under-performed utilities and the S&P 500 (and certainly the NASDAQ) for the second straight week.  Oil prices were also down sharply this week, and finished outside of the recent range of $45-50/bbl that the market seemed to be settling into the last few months.
A Dark Force Awakens
Like in August when PAA reported results that stunned the sector, this week saw MLPs get rocked by another large capitalization midstream bell-weather announcing challenged growth in 2016.  However, the impact across the sector was more muted than it was in early August when PAA sounded the initial alarm on reduced 2016 distribution growth (-8.9% that week).  That 6.1% decline for the Alerian MLP Index was also concentrated among larger MLPs, as evidenced by a much smaller decline for the equal weight version of the same index, which declined “just” 4.8%.
In last week’s post, I asked what turned out to be a pretty relevant question about what KMI would do about its likely reduced dividend growth prospects. 
The overwhelming majority of respondents expected to get no update to KMI’s growth prospects this quarter, instead believing KMI would only announce changes around its January analyst day.  KMI surprised the market by reducing guidance from 10%+ to 6-10%.   KMI also announced that it has decided on an alternative financing vehicle that will enable KMI to avoid issuing common equity until at least the second half of 2016.
Flexibility Ignored
The price action that followed across the MLP sector seemed to take KMI’s choice to seek financing outside of the traditional equity markets as evidence that all MLPs are in a similar situation.  It’s true the equity capital markets are very challenged right now.  But, virtually every MLP has more financial flexibility than KMI in the following ways:

  • MLPs need less capital: KMI’s size makes the amount of capital it needs to invest and to raise on an annual basis much larger than almost all MLPs.
  • MLPs have less leverage: KMI’s leverage ratio is more than 5.5x and will remain that high for the next several years. There are very few MLPs that carry that much leverage, so many MLPs have the ability to finance growth with borrowings.
  • MLPs have more coverage: The majority of MLPs carry more distribution coverage and therefore have more retained cash flow than KMI.
  • Sponsor Support: Some MLPs have general partners that can potentially support an MLP. That support can come in the form of buying back units, buying new primary shares, selling assets at attractive prices down to the MLP, or IDR waivers that reduce the amount of cash flow that goes to the MLP.   KMI has no such support.

The market doesn’t seem to be distinguishing among MLPs that have some of the above characteristics.  A clear example is EQT Midstream Partners.  EQM checks all of the above boxes.  EQM has very low leverage, very high retained cash flow, strong sponsor support, and a manageable amount of growth capex.
EQM happened to announce results on the same day as KMI, and despite solid results and a virtually opposite financial profile vs. KMI, EQM finished Thursday down 3.6%, compared with KMI down 5.3%.  Over time, fundamentals should win out, but technical and emotional factors continue to prevail in the short term.
Winners & Losers
The top five was a mix of small-cap MLPs of mostly non-midstream sectors.  HMLP rallied after announcing the quarterly distribution while the other names didn’t have any company specific news. The bottom five consisted of all upstream MLPs including two that cut distributions (to $0.00 in the case of MCEP).
Speaking of distribution outlooks not priced in, variable distribution MLP EMES (not pictured above) announced it will not pay a distribution this quarter, and it declined 24.8% this week, including a 27.7% drop on Friday.
The constituents of the top and bottom five were unchanged from last week although there were some slight changes in the order.  The top 5 MLPs all announced distributions this week, but only HEP traded up.
General Partner Holding Companies
GP returns were all negative for the week and underperformed MLPs.  CPGX was the top performer and ATLS was the worst performer for the 2nd week in a row.  As discussed above, KMI had a rough week, down 7.9%, but given that it is not an MLP or a GP, its not pictured below.
Worst Weeks
This was the 14th worst week ever for MLPs.  Below is a chart that highlights the unprecedented uncertainty and volatility MLPs have experienced since August 2014.  Of the 20 worst weeks ever for the Alerian MLP Index, 7 happened in the last 13 months.  Most of the other weeks listed above were either the result of the financial crisis, the flash crash in May 2010, 9/11/2001 or some other extreme event like a big MLP tax status scare.
Two key dynamics have driven the extreme volatility: (1) oil price volatility driving ongoing uncertainty of growth capex opportunities for MLPs and (2) money flows from open end MLP products that allow for faster money to pop in and out of MLP exposure with less friction than prior to their existence (most were launched after 2010).  Both of these factors seem to be the new normal, which implies continued volatile price action.  On the positive side, sharply lower weeks have generally met with some level of positive price action the following week.
News of the (MLP) World
Limited MLP news this week.  Again no equity was issued, although a new MLP IPO was added to the lengthy (and increasingly stale) backlog.  KMI announced a small acquisition, but barely relevant for them.  I counted 33 MLP distributions announced, including 22 increases and 2 cuts (both non midstream MLPs).
Capital Markets

  • Noble Midstream Partners (NBLX) filed initial registration statement to raise up to $100mm in MLP IPO (filing)
    • Midstream-focused MLP with Noble Energy (NBL) as the sole sponsor and with assets focused in the DJ Basin area
    • NBL is already a sponsor (jointly with CNX) of a midstream MLP (CONE Midstream – CNNX) with focused Marcellus gathering assets

M&A / Growth Projects

  • Kinder Morgan (KMI) announced acquisition of 15 refined products terminals and related infrastructure from BP for $350mm (press release)
    • KMI will form a JV with BP to operate 14 of the 15 terminals, and KMI will be a 75% owner of the JV
    • Not exactly the kind of game-changing M&A Kinder was touting early in 2015, and not enough to keep its growth rate up
  • Spectra Energy (SE) announced final details of previously announced pipeline asset contribution agreements related to asset transfer from SEP to DCP Midstream, LLC (press release)

Distributions / Other

  • Distribution announcements
    • SHLX +7.9%
    • PSXP +7.0%
    • MPLX +6.8%
    • EQM +5.5%
    • SXL +4.6%
    • KMI +4.1%
    • TLLP +3.8%
    • MMP +3.0%
    • NAP +2.4%
    • SEP +2.0%
    • ENLC +2.0%
    • HEP +1.8%
    • OKE +1.7%
    • RMP +1.6%
    • RRMS +1.5%
    • ENLK +1.3%
    • NGL +1.2%
    • MWE +1.1%
    • SMLP +0.9%
    • CPLP +0.8%
    • GLP +0.7%
    • CCLP +0.5%
    • ENBL +0.6%
    • NRP -50% quarter over quarter
    • MCEP suspends distribution
  • CEQP announced 1-10 reverse unit split
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