The past few months have been a nightmare for energy investors. With crude oil falling to multi-year lows and expectations of continued weakness, the end is nowhere to be seen. The weakness seems to have also caught up with MLPs – a class once considered immune to commodity prices, a golden goose in times of the oil boom.
However, some MLPs are less susceptible to commodity prices than others and an opportunity lies hidden in these. So it would wrong to shun off all MLPs by judging them on similar lines without even having a basic understanding of these.
MLP Basics
Well, we are aware that MLPs are master limited partnerships that deal in natural resources. They have two classes of owners – the general partner (GP), which is basically a major energy firm or investment fund, or limited partners (LP), the unitholders. These are exempted from paying taxes at the partnership level and pass on most of their income to the unitholders.
However, at this point of weak commodity pricing, it is important to evaluate MLPs on the basis of their operations. The MLP business can be broadly classified into four types – exploration & production (E&P), transportation, storage and processing.
Needless to say, E&P MLPs are not the best investments at this time. Falling oil prices mean lower earnings per barrel while costs remain the same, thus, shrinking margins.
However, the oil slide has a different impact on the other types of MLPs. The transportation and storage firms have more fee-based income. These generally have long-term, fixed tariff contracts for their assets. Thus, oil trading at $100 per barrel or at $50 per barrel does not have any significant impact on their earnings.
Transportation and refining MLPs are also set to benefit from lower gasoline prices. The reduced pump prices will likely drive consumer demand, resulting in more sales volumes for refiners.
Many of these transportation and refining MLPs have been wrongly targeted during this oil carnage. These remain fundamentally strong, continue to offer higher income to investors through increased distributions and could very well emerge as the shining knights.
The Right Strategy
Since these businesses differ structurally from companies, stock picking on the common parameters such as PE ratio or Price/Sales ratio does not work here. For MLPs, factors such as Distributable Cash Flow (DCF), Distribution Growth and Coverage Ratio are the key selection criteria. MLPs are valued on their ability to generate, maintain and grow cash distributions.
An optimal choice would be one that has not only consistently paid and grown its distribution, but one that also has a distribution coverage ratio greater than 1. The higher the ratio the better it is, as it ensures the safety of the distribution payment. Also, as discussed above, focusing on MLPs that have a substantial portion of the cash flow coming from fee-based activities is an added advantage.
3 Energy MLPs That Look Good
Based on the above strategy, the following MLP stocks look attractive:
Spectra Energy Partners, LP (SEP)
Houston, TX based Spectra Energy Partners has a robust portfolio of natural gas pipeline and storage assets. The partnership has consistently paid and increased distribution. The last distribution paid was 57.63 cents, marking the 28th consecutive quarterly hike. Spectra Energy Partners has a TTM distribution coverage ratio of 1.38x.
The stock has also beaten the Zacks Consensus Estimate in three of the trailing four quarters and has an average positive surprise of 8.67%. Another beat is likely as the partnership has a Zacks Rank #1 (Strong Buy) and an Earnings ESP of +7.25%.
Magellan Midstream Partners, L.P. (MMP)
This partnership owns and operates a diversified portfolio of energy infrastructure assets that generate stable and recurring fee and tariff-based revenues. It has consistently paid and grown distributions over the past couple of years. Magellan Midstream has a TTM distribution coverage ratio of 1.60x.
Magellan Midstream has surpassed the Zacks Consensus Estimate in the three of the trailing four quarters with an average positive surprise of 17.71%. Another beat is likely as the partnership has a Zacks Ranked #3 (Hold) and an Earnings ESP of 6.45%, which may positively reflect on the stock price.
Enterprise Products Partners L.P. (EPD)
Headquartered in Houston, TX, Enterprise Products Partners is a leading North American firm engaged in providing a wide range of midstream energy services to the producers and consumers of natural gas, natural gas liquids (NGL) and crude oil. The partnership has multi-billion dollar projects under construction that support meaningful distribution growth. The partnership recently increased its quarterly cash distribution to 37 cents, reflecting growth of over 5.7% from the previous payout.
The partnership has trailing 12-month (TTM) distribution coverage of 1.56x. The partnership has also surpassed the Zacks Consensus Estimate in three of the last four quarters, with an average positive surprise of 2.22%. Enterprise Products Partners currently has a Zacks Rank #3.
Looking Beyond the Current Weakness
Currently, oil is deeply entrenched in the bearish territory and has fallen below the $50-a-barrel level. The commodity is likely to linger here in the first half of the year, with recovery expected in the latter part of 2015.
However, growing supply means higher growth and expansion projects for these midstream MLPs. Their low commodity exposure and more fee-based cash flow options make them better suited to withstand the present market scenario. Also, the fact that MLPs often offer a higher yield than other stocks makes them more lucrative as investment opportunities.
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