March 9, 2013
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With the S&P 500 up 2.2% and the alerian mlp index up just 1.5%, MLPs lagged the market this week, but did make a brand new all time high, and a new 12 month low yield. Commodity prices were up with natural gas making the biggest move, up 5.0% this week and helped by Thursday’s storage report. For the year, MLP Index is up 13.5%, 15.1% with distributions.
Winners & Losers
Big moves this week, led by MPLX and BKEP, both up double digits. GLP was up 9.1% after announcing CNG partnership. GLP has changed the buzzwords associated with it the last year or two from heating oil and propane to Bakken railroads and compressed natural gas, so good work by them. Not many MLPs in the red this week, and no real trend in the bottom five.
GLP jumped back ahead for the year. Liquids and logistics MLPs dominate the top 5. Only 3 MLPs are down for the year, hopefully you didn’t own all three on 12/31.
Historical Yield
Yield isn’t the best metric to evaluate MLPs, and it can be distorted by distribution coverage and broader interest rates, but its the most accessible and widely followed. Its been a while since we’ve looked at yields here, so thought we’d take a closer look after the MLP Index closed the week at a fresh all time high.
See below for MLP Index yield charts looking back at various historical periods. The MLP Index yield is currently 5.89%. First up is the longest time period, which makes the last 2 years look expensive, but not at all-time lows reached in 2007. Declining interest rates during most of this period and extremely low interest rates the last several years distort this picture.
The last five years, MLP Index averaged 7.39% yield, compared with the current 5.89% yield. After the initial recovery from the financial crisis, the MLP Index has traded between 7% and 6%, with anomalies above and below that range quickly corrected.
Early June, MLP Index yield hit 6.86%, the highest its been in the last 12 months. There was another spike up to 6.81% on 11/15/12, around distribution ex-dates. The last time MLP Index yield was above 7% was back in October 2011, and at no point in the last two years has the MLP Index yield been higher than 7.5%. Will MLPs ever yield that high again? History says yes, but if you have recently come to MLPs, you may think this chart of recent history is normal, because as Daniel Kahneman repeats in his book Thinking Fast and Slow: “what you see is all there is”.
In February 2012, a little over a year ago, MLPs were yielding less than they are today (by 5 bps). The MLP Index has increased in price by 6% since then and produced 12% total return. Could that happen again the next 12 months? What conditions would be necessary for a repeat 12%+ return the next 12 months for the index? It would be hard to create a more benign broader stock market environment for MLPs than the last 12 months, with improving unemployment, crazy low interest rates and low grade crises / fears.
Commodity prices have been anything but benign the last 12 months, so maybe you hang your hat on a turnaround in NGL / natural gas prices that drives more activity and volumes. But with the structural imbalances in those products and with oil production continuing to ramp, NGLs and crude oil may lag and weigh on MLPs. Natural gas has already made a substantial recovery. If those prices hold, the natural gas picture the rest of this year will be much better than it was last year, but still far away from making dormant basins economic again.
So, what’s the bull case for MLPs from here? Any bull case has to be heavily reliant on increased yield appetite, new money flowing into the sector from new sources (pension funds, late adopting individuals, etc). Something you hear when MLPs are at historically high valuations: maybe we’re at the inflection point whereby MLPs get repriced with lower yields like REITs. I don’t think that’s happening, and I would at least wait until the MLP Index broke its all time low yield of 5.37% before starting to believe it.
Maybe your MLP bull case involves MLPs growing distributions more rapidly than the 7% that the MLP Index implied distribution grew in the last 12 months? Seems pretty unlikely. Proceed with caution, at the very least wait a week or two for MLP equity offerings to get rolling again before putting fresh money to work in broad MLP instruments (there remain individual MLPs that are likely to outperform the sector).
News of the (MLP) World
I was genuinely surprised there weren’t more equity deals this week besides the one from WPZ. I’m still expecting the floodgates to open at some point soon. Also, fyi, its Spring Break across Texas this week, so MLP execuives and senior bankers (just the ones that like to spend time with their families, smaller subset) may be taking this week off. Also, it happens to be SXSW week here in Austin. I haven’t ventured into town to check it out (As evidenced by my Saturday night posting). Maybe I will next week just so I can send out a post from the SXSW scene like so many podcasts and movies do.
Equity
M&A / Growth Projects
Permain Differential
Several upstream MLPs that reported this week discussed the impact of wider differentials for Permian produced crude oil relative to Cushing. Below is a chart showing the differential of West Texas Sour Crude to WTI in Cushing. In mid-November that basis blew out and remained depressed until the end of January, but now sits at just a dollar. For the previous 12 months, the basis differential has averaged -$6.31/bbl, compared with -$3.11 the last 5 years. The blowout was caused by refinery downtime and increased production. Upstream MLPs have combated this trend by adding basis swaps to lock in tighter differentials. Click on the chart to see a larger version.
