Master Limited Partnerships (MLPs) have become a popular financial structure for investors in the energy space. The MLP structure avoids a corporate tax, allowing the MLP to distribute more of its cash flow in dividends to unitholders compared to traditional C-corporations.
MLPs tied to midstream infrastructure offer companies a vehicle to maximize the payout from long-life assets, which are generally tied to fee-based infrastructure. The idea was that the fee-based structure would leave midstream MLPs less exposed to commodity prices. MLPs can also be structured around E&P assets, but those tend to be much more sensitive to oil prices, making them a much risker investment.
While midstream MLPs are billed as being less commodity price sensitive than traditional energy investments, they are not immune to the downturn in oil prices. In the last six months, the median price of midstream MLP stocks has fallen 39%, according to EnerCom Analytics’ MLP Weekly. In that same time period, E&P company stocks have fallen by 41% at their midpoint, only marginally worse than the supposedly insulated midstream MLPs.
For a better sense of what the commodity price decline has meant for the MLP sector, and where MLPs are headed in the future, Oil & Gas 360® spoke with Alerian President and CEO Kenny Feng. The Alerian MLP Index (ticker: AMZ) is a benchmark index for energy MLPs. Before Alerian, according to Feng, tracking MLPs was “like tracking the U.S. economy without the S&P 500.”
MLPs using different approaches to weather the storm
The entire energy sector has been put under pressure by the drop in oil prices, and MLPs are no different. MLPs attract investors with large dividends and a promise for more growth, but if their general partner, or parent company, is unable to dropdown attractive assets to the MLP for growth, it becomes increasingly difficult to grow, or even maintain, the dividend.
“You are starting to see a wide disparity in MLPs in everything from leverage and growth visibility, to yield,” said Feng. The stress from the downturn has affected MLPs to different extents, and the companies’ general partners, the main source of dropdown assets for the MLPs, are handling things in different ways.
“Just like parents come in all shapes and sizes, so too do general partners,” said Feng. “Some MLPs haven’t suffered nearly as much because their general partners have massive dropdown capabilities. Some are waiting to see which way the market goes, and others are pursing alternative strategies,” Feng said, mentioning CenterPoint Energy (ticker: CNP, CenterPointEnergy.com).
Houston-based CenterPoint holds a 50% general partner interest, and a 55.4% limited partner interest in Enable Midstream Partners (ticker: ENBL, EnableMidstream.com), which it is considering selling, or spinning-off. CNP President and CEO Scott Prochazka said the company would also explore the use of the REIT business model for all or part of CenterPoint’s utility assets.
“If the market comes back in the next six months, many companies will probably be fine,” said Feng. But if things continue the way they have been for the last year, pressure could continue to build on the MLP space, forcing more companies to seek alternatives.
M&A likely on the horizon, but the market needs to find a bottom first
Many were surprised at how well the U.S. oil and gas industry held up against the falling price of oil. Many expected large amounts of distressed assets to come to market, but instead we saw the the lowest levels of M&A seen in a decade in 2015. The MLP space saw a similar trend, minus a few larger deals, but M&A could ramp up if prices find a stable foothold.
“We haven’t reached a place yet where present realities meet future expectations,” said Feng. “The buy-ask spread is still too wide.” Buyers are worried about buying assets that could continue to devalue, and sellers don’t want to divest assets that could be worth more in a few weeks if oil prices remain volatile.
“There’s a sort of joke about all this,” said Feng. “When the markets go south, first you sell your bad assets, then you start looking at joint ventures, then finally you start looking at mergers. We might be approaching that JV stage, but people are waiting for things to get worse before they jump into big deals.”
Private equity firms, in particular, are waiting to make sure we’ve found the bottom of the market before they start acquiring new assets. “Private equity players don’t see a reason to invest with valuations where they are right now,” said Feng. “They’re waiting for things to get worse so they can pick up assets for pennies on the dollar.”
What lies ahead for MLPs?
In the short-term, what might happen to MLPs depends solely on the answer to the question the whole oil and gas industry would like the answer to: where are oil prices headed? Market volatility continues to scare off investors said Feng. “Investors would almost prefer bad news over uncertainty,” Alerian’s president joked. But the old saying, markets loathe uncertainty, does apply across the board.
MLPs structured around upstream assets likely face the hardest road ahead of them. With their assets being depleted, and worth substantially less than they were a year ago, many upstream MLPs are going to have a hard time maintaining distributions.
Like the wider oil and gas space, midstream MLPs seem could come out of the downcycle ready to pick up stream though. Companies like Magellan Midstream Partners (ticker: MMP, MagellanLP.com) look prepared to make it through the downturn and hit the ground running when prices recover.
Magellan’s current yield of 4.9% is below the group median on EnerCom’s MLP Weekly of 11.6%, but the company has strong metrics that leave it in a more stable position. The company’s dividend coverage of 1.3x is more than twice the group median of 0.6x, while its EBITDA margin of 52%, and its FCF per unit of $2.67 both surpass group averages of 20% and $0.54, respectively.
“MLPs are fundamentally a long-term investment,” said Feng. “That story hasn’t changed for us. If you talk to people who have been in the industry for a long time, they say this is painful, but not that it’s irreversible. They believe in the ingenuity of the American worker and American business. They believe in the shale revolution story, and others like it, over the long term.”
While MLPs may be facing similar problems as the rest of the energy space, those that are able to survive the commodity price downturn will continue to be attractive investment vehicles, said Feng. “Those who continue to invest and look at the long-term are likely to be rewarded.”