As part of our standard asset class review we recently took a deep dive into MLPs. Given recent performance and the seemingly high frequency of questions we have provided a brief summary below and our expanded outlook for the asset class.
- Tax reform did not significantly change the attractiveness of these assets or how to access them.
- The MLP market is going through some changes. We believe this as a positive for investors on a net basis, helping shore up distribution payments and address some structural issues for the asset class.
- Performance has been disappointing starting with the energy downturn in 2014, followed by the 2016 reprieve and 2017 backslide. 2017 negative returns were driven by retail sellers and equity issuances by MLPs.
- The outlook is bright. The fundamental story remains as must-run infrastructure assets, valuations are low, stability of current distributions are higher today than recent history and catalysts exist like U.S. energy exports and friendly growth polices by the current administration.
The opportunity in MLPs does not come without risk. There are many moving parts to this asset class, likely leading to current opportunities.
- Valuations are Attractive – There is not much out there that looks cheap today. MLPs are one of those spots.
- Valuations are attractive, especially compared to other equity markets. MLPs trade around ~12x free cash flow vs. ~17x for equities broadly(1).
- The result is our second highest capital market assumption (CMA) ever on MLPs since incepting coverage in 2007. Only 2016 expectations exceeded the current 11.1% expectation at 11.4%.
- More than just our numerical assumption, it is also relevant how MLPs stack up to other growth assets. The spread today for MLPs vs. all cap U.S. equity is the largest it has ever been driven by lower equity returns and rising MLP assumptions.
- Greater Support – Two thirds of MLP returns over time have come from the distribution made by the firms. As a result of recent scrutiny and dividend cuts, distribution coverage is now 1.2x, close to historical highs, offering greater certainty of receipt of perceived opportunity.
- Export Kicker – Midstream pipes make money on volume. The more they move, the better their revenue. The U.S. has had a self-imposed ban on exporting oil since 1975 following the Oil Crisis in 1973. This ban was lifted in December of 2015 allowing the U.S. to export to countries beyond Canada. Current and future projects set the stage for growth in volume to pipes directed toward waterborne ports to ship abroad. The graph below shows a short glimpse of what has happened to exports since this ban was lifted.
Source: Tortoise Capital Advisors
• MLP Cheerleaders – Scott Pruitt, the new head of the EPA, is an energy proponent. The current administration is keen on growth and jobs, many of which manifest in domestic energy (think headlines like infrastructure, coal and shale gas), and Rex Tillerson, Secretary of State and former CEO of ExxonMobil, is a likely champion of U.S. energy abroad.
For further information, please contact any of our financial advisors at New England Investment and Retirement Group, Inc.
(1.) Energy Income Partners LLC, Fourth Quarter 2017 Investor Newsletter, page 5
Note: This report is intended for the exclusive use of clients or prospective clients of New England Investment and Retirement Group, Inc. Content is privileged and confidential. Any dissemination or distribution is strictly prohibited. Information has been obtained from a variety of sources believed to be reliable though not independently verified. Any forecast represent median expectations and actual returns, volatilities and correlations will differ from forecasts. Past performance does not indicate future performance. This paper does not represent a specific investment recommendation. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice.