MLPs: Finding Yield
Federal Reserve Chair of the Board of Governors of the Federal Reserve System
After seven years of the most accommodative monetary policy in U.S. history, Janet Yellen and the Federal Reserve decided on December 16, 2015 to raise the federal funds target rate from 0 to 0.25 percent to 0.25 to 0.5 percent. This marked a change in opinion of the Federal Open Market Committee regarding the health of the U.S. economy and its ability to withstand raising interest rates.
What followed was a slowing of the global economy and a pullback in the U.S. markets, which have now moved into correction territory, from a DJIA close of 17,749 on December 16, 2015, to 15,660 on February 11, 2016, a change of -11.8%. Focus has shifted to whether the Fed will continue to raise rates through 2016 and the slowdown in manufacturing in the U.S.
Janet Yelllen has said that rate raises will be gradual and grounded in data if or when they do occur.
Graph: EnerCom Analytics
Lost Luster
Leading up to the Fed’s decision, dividend paying stocks had lost some of their luster. With the prospect of a quick move toward higher rates waning, dividend paying stocks have had a resurrection of sorts, with investors facing the possibility of stagnant rates for the foreseeable future, as the outlook for 2016 has shifted to stable interest rates.
While economic data that is being reported is up and down just about day to day, leading to highly volatile securities markets, there are equity investments with substantial yields for non risk-averse investors.
The depletion of global commodity prices has led to the energy sector taking a well-publicized beating over the last year and a half. And the dividend paying MLP sector has not been immune. The 59 midstream MLPs in EnerCom’s database experienced an average loss of -36% of stock value in 2015, while the 11 E&P MLPs lost an average of 71%.
The effects of lower cash flows from depleted commodities prices along with oil and gas industry stock value depletion have been well documented, with some highly leveraged companies driven to bankruptcy. Costs are being cut, overhead is being slashed, operational optimization is being assessed, and the best assets being high graded as rigs are shut down.
One aspect of the collapse of oil prices and stock values is the rise of dividend yields. According to Oil and Gas 360®’s MLP Scorecard, yields in the midstream MLP sector have risen from 6.4% to 15.9% between April 1, 2015 and February 19, 2016. This is in spite of the fact that several companies have cut their dividends. Obviously volatile share/unit prices that follow the volatile commodities prices will affect dividend yields day to day. And due diligence is warranted because dividend reductions and suspensions within the energy sector are in the news on a regular basis as energy sector cash flow suffers.
Silver Lining for Energy Investors?
With oil prices hitting a new low of $26.11 on February 11, 2016, some energy sector analysts have prognosticated that prices could be seeing a bottom. Some OPEC members and others have called for a production freeze, U.S. rig count is close to breaking the 500 barrier in a downward fashion, and the EIA’s latest data leads the agency to call for a rebalancing in 2017.
Is it time to begin the search for values in the energy sector? With stagnant interest rates on the horizon, higher dividend yields from energy MLPs could be attractive to investors with an appetite for risk.
As a group, midstream MLPs have seen trading multiples decline. For the period of April 10, 2015 to February 19, 2016, EV/EBITDA for the group has dropped to 10.8 times from 17.4 times (excluding companies with negative EBITDA). Price/cash flow per share has decreased to 6.0 times from 12.3 times. These multiples point towards a significant decrease in market value relative to the cash generated by these companies.
More information on MLPs can be found in Oil & Gas 360®’s weekly MLP Scorecard. The free report delivers 33 comparative metrics on 70 MLPs in the industry. You can sign up to receive the free weekly MLP Scorecard report in your email here.
