​Coming Down: MLPs Ain’t Got Wings

Hedgeye  |


"Well the good ol’ days may not return
And the rocks might melt and the sea may burn
I’m learning to fly, but I ain’t got wings
Coming down is the hardest thing"

-Tom Petty

There’s been a bit of a panic in the energy MLP sector in recent weeks.

My inbox has been full of questions all asking some version of, “What’s going on with MLPs lately?!”

The benchmark Alerian MLP Index (AMLP) is down 6% in October alone and is near its lowest level since the energy panic of 1Q 2016. It’s been a rough few years for the energy sector, and midstream has not been immune.

Buy-side chat rooms and sell-side notes are full of speculation as to why:

Tax loss selling! Rates rising! BP’s MLP IPO prices this week!

Maybe it’s some of that, maybe it’s none of that.

Maybe it’s that the “MLP kimono” has been opened, investors saw something they didn’t like, and what they saw can’t be unseen.

That’s what we’re going with today.

For two decades MLPs have been marketed as having attractive characteristics and low risk: “high current yield,” “safe and growing distributions,” “yield plus growth equals total return,” “stable cash flows,” and “inflation protection.”

Fast-forward through a proliferation of MLPs, a shale-fueled building boom, a disgusting amount of fees paid to General Partners and investment bankers, and a major industry down-cycle… We come to find out that MLPs were sold on, at best, half-truths and exaggerations.

You can’t have US midstream bellwethers like Kinder Morgan (KMI), Plains All-American (PAA), and Williams (WMB) slashing dividends when the sales pitch is “toll road.”

Recently, two MLPs again stoked investors’ concerns.

Genesis Energy LP (GEL) – a name we’ve been negative on for two years now – cut its distribution by 31%. Incredibly, the CEO had this to say about it:

“…it makes no sense to this board to continue paying out 11% money..."

Our translation: “Our dividend is only sustainable if our stock price is high enough to raise the equity to pay it.”

And last week MLP juggernaut Enterprise Products Partners (EPD) subtly shifted its capital allocation strategy, opting to pay out less in future distributions and fund more of its capital program with internally-generated cash flows. In other words, paying dividends out of free cash flow – what a novel concept!

We do think that EPD’s move was a seminal moment for the MLP sector. Slowly, things are moving in the right direction, and investors are seeing more clearly.

They are starting to see MLPs for what they really are: capital-intensive businesses with mediocre returns on capital operating in a highly-competitive and cyclical industry, with low free cash flow generation, high debt leverage, and, in many cases, atrocious corporate governance. That’s not a business that should trade at 30x earnings. MLPs aren’t special.

The MLP heyday is over, and good riddance to it. Many MLP investors were burned while a small number of insiders (GPs), bankers, and lawyers made fortunes.

We like the new direction that the sector is begrudgingly heading in. We’re hopeful that eventually it gets to a place where the business models and corporate governance are sound, and valuations are attractive. Still, there’s a lot of work to be done on those fronts.

Our favorite midstream short ideas are Tallgrass Energy Partners (TEP), SemGroup Corp. (SEMG), and Genesis Energy LP (GEL).

By Kevin Kaiser of Hedgeye Risk Management

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DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.

Companies

Symbol Name Price Change % Volume
GEL Genesis Energy L.P. 20.13 -0.42 -2.04 507,443 Trade
PAA Plains All American Pipeline L.P. 18.15 -0.01 -0.06 4,778,947 Trade
WMB Williams Companies Inc. (The) 22.44 -0.20 -0.88 18,374,267 Trade
KMI Kinder Morgan Inc. 21.76 0.80 3.82 25,959,461 Trade
EPD Enterprise Products Partners L.P. 27.80 0.09 0.32 4,672,637 Trade
amlp Alerian MLP

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