As the rout in oil prices has pressured the stocks of both large integrated oil companies and smaller explorers, it has also weighed heavily on a related group of publicly traded investment vehicles known as master limited partnerships.
That may be creating bargains for patient, savvy investors in the beleaguered energy sector.
Energy MLPs are tax-advantaged entities that own operating assets such as pipelines, transmission infrastructure and storage. They distribute their excess cash flow as dividends, making them attractive to yield-seeking investors. For midstream MLPs, their revenue comes from transporting or storing oil or natural gas for other companies.
MLPs have become a popular investment in the energy sector because, in theory, they aren’t as exposed to the ups and downs of commodity cycles as oil and gas companies, says Morningstar analyst Robert Goldsborough, who tracks MLP funds. Still, about 25 percent of the sector’s cash flow is sensitive to commodities, and that, coupled with poor market sentiment on MLPs, has led to a lot of pain in the sector.
Over the last year, international Brent oil prices have been roughly halved amid a supply glut and worries about demand. Brent recently dropped below $30 a barrel, compared with its average of about $100 from 2011-2014. Oversupply has also pressured natural gas, with Henry Hub prices less than half their average from the first quarter of 2014.
The Alerian MLP index, which includes dozens of MLPs, is down nearly 47 percent over the past year.
MLPs have gotten so trashed because the market has become overly fearful that prolonged weakness in oil prices will cause weaker producers to go out of business, says David Bahnsen, chief investment officer of the Bahnsen Group, part of Chicago-based private wealth management company HighTower Advisors. That would hurt revenues by diminishing the volume of oil and gas flowing through pipelines owned by MLPs.
The drop in oil and gas prices has also increased borrowing costs for MLPs, says Curtis Holden, senior investment officer at Houston-based Tanglewood Wealth Management. That’s of particular concern as these vehicles have to issue debt to fund new projects.
Chuck Self, chief investment officer at Wisconsin-based investment manager iSectors, says MLPs have gotten beaten up more than they should. Even if a number of production firms shut down, it would only be a small percentage of total oil production, he says. Additionally, pipelines have been around for decades and are servicing companies that are more likely to be in good financial shape.
“At this point we would definitely be buyers of this space,” Bahnsen says.
While the market will punish MLPs that are highly leveraged, those with stronger credit, good contracts and enough cash flow to cover their dividends will be rewarded, he says.
Enterprise Products Partners (ticker: EPD) is Bahnsen’s top pick among MLPs because of the quality of its assets, its dividend growth track record and its yield of 7 percent. He also likes MPLX (MPLX) because its dividend growth outlook remains substantial, and Spectra Energy Partners (SEP), whose shares are down only 9 percent over the past year despite the wider selloff.
“There are some pretty divergent valuations right now,” Goldsborough says. Morningstar equity analysts say Energy Transfer Partners (ETP) is overvalued while Magellan Midstream Partners (MMP) is undervalued, he says.
Individual stocks versus funds. Because there are sound MLPs that have gotten dragged down in the wider selloff, Bahnsen recommends picking individual names rather than investing in broader MLP-related funds.
Holden recommends shying away from upstream exploration MLPs because of their debt and risk of dividend cuts or bankruptcy. Instead, he says, more traditional midstream MLPs, such as those that own pipelines, could be a better buy. He also recommends picking a handful of MLPs for diversification.
Self says his firm uses MLP exchange-traded funds because their diversification and current cheapness should more than make up for underperforming, or even potentially bankrupt, components. His top pick is the Global X MLP ETF (MLPA), which he says is a low-cost way to invest in the pipeline sector.
A good way to diversify holdings from that passively managed fund is to invest in Kayne Anderson MLP Investment Co. (KYN), he says. Although more expensive, its active management, in theory, should be able to steer the fund away from the more troubled MLPs, Self says.
Additionally, owning funds can be more advantageous for tax purposes than owning individual MLP stocks, Self says.
Holden — whose firm invests in the Advisory Research MLP & Energy Income Fund Class I (INFIX) and Salient MLP & Energy Infrastructure Fund II Class I (SMLPX) — says owning individual MLP stocks can require tax preparation not necessary with other types of equities. MLPs can also trigger taxes in individual retirement accounts, he says.
In addition to funds, the MLP sector also has exchange-traded notes, which are backed by the credit of an issuer, like a bank, instead of by equity or commodity holdings like ETFs. Both Holden and Goldsborough suggest the JPMorgan Alerian MLP Index ETN (AMJ) and the ETRACS Alerian MLP Index ETN (AMU).
Expect volatility. As oil prices have been stabilizing, Holden says a bottom may be forming in the MLP market, and now could be a good time to buy if that holds. Still, there will be a lot of volatility in the sector, he says.
In addition to a bounce in oil prices, the current uptick in the MLP space is “because of how silly the overselling had been,” Bahnsen says.
Investors who can buy MLPs now and ignore the day-to-day volatility should be happy with their MLP purchases, experts say. “For an investor that has some patience and doesn’t get shaken up by volatility, it’s probably a good time to dip your toe in the water,” Holden says.
More from U.S. News
7 Dividend ETFs for the Income-Minded Investor
Chinese ETFs: 9 Ways to Play the Middle Kingdom
11 Tips for Investors in Their 30s and 40s
Bottoming MLPs Offer a Bright Spot for Energy Investors originally appeared on usnews.com
