What Happened To The MLPs?

11/9/2015


For nearly 19 years, master limited partnerships (MLPs) trounced the S&P 500 Index.

From the end of 1995 through two years ago, the Alerian MLP Index delivered a total return of 1,424%, nearly five times the return of the S&P 500. In fact, while MLPs are known for their generous dividends, the S&P 500 Index's total return of 296% including dividends lagged the MLP index's 355% return excluding dividends.

Then things changed.

Over the last two years, the Alerian index has delivered a negative return of 15%, while the S&P 500 has returned 25%. Several factors deserve blame for MLPs' poor performance, including concerns about an interest-rate hike making high-yield stocks less appealing relative to bonds and the possibility that the federal government will change the law to take away MLPs' preferential tax treatment.

But probably the biggest culprit is the plunge in oil prices. West Texas Intermediate crude oil traded at nearly $95 per barrel two years ago. It bounced between $91 and $108 for most of the next 12 months before plummeting in the second half of 2014. As of Nov. 3, oil traded at $48 per barrel, 22% below this year's high of $61 in June and 56% below last year's high of $108, also in June.

Why should oil prices have such an effect on MLPs? Because most master limited partnerships operate in the energy sector. MLPs aren't true stocks, but publicly traded partnership units. If they generate at least 90% of cash flows from "qualifying sources" — which for the most part limits them to natural resources, commodities, or real estate — their income isn't taxed at the corporate level.

About 75% of MLPs operate in the energy sector, mostly in midstream businesses such as pipelines. We don't recommend any MLPs on our recommended list, but we do provide an Alternative Income Watch List of MLPs and real estate investment trusts (REITs) at www.DowTheory.com/Go/Alt. Our Top 15 Utilities portfolio, shown in Utility Review, contains three MLPs.

Pipelines charge to transport energy, and conventional wisdom suggests they shouldn't be affected too much by changes in the price of that energy. Unfortunately, reality often trumps conventional wisdom.

In the first three quarters of this year, U.S. oil prices averaged $51 per barrel, the lowest since the three quarters ended March 2009. During each of the first two quarters of this year, more than half of the Alerian MLP Index's 40 companies in the oil & gas storage & transportation industry posted revenue declines. This probably also happened in the third quarter.

In 12-month periods over the last 10 years, our Quadrix stock-rating system has worked well for MLPs, with the top one-fifth of the Alerian index as measured by Overall score outperforming the average stock in the index by an average of 4.4%. The most effective category score is Value, with 4.8% outperformance, and three individual valuation ratios have delivered at least 5% outperformance:

• Price/sales
• PEG (price/earnings to growth)
• Price/cash flow to three-year median

The table below lists top-rated MLPs that look cheap based on the key valuation ratios. Two of them produce coal, which, like oil, sells at unusually low prices. We don't recommend any MLPs for purchase, but they're among the most appealing.

VALUE MLPs
We follow 31 MLPs in our Alternative Income Watch List (www.DowTheory.com/Go/Alt). Of the nine MLPs rated A (above average), only the four below are cheaper than the typical MLP in two of three key valuation ratios.
--- Valuation Ratios ---
----- Total Return -----
---------------- Quadrix Scores ----------------
Company
(Price; Ticker)
Div.
($)
Yield
(%)
Price/
Sales
PEG
Price/CF
To 3-Yr.
Median
6
Months
(%)
2 Yrs.
(Ann.)
(%)
5 Yrs.
(Ann.)
(%)
Value
Quality
Overall
12-
Factor
Reranked
Overall
Industry
Alliance Holding ($29; AHGP)
3.84
13.5
0.7
0.9
0.4
(41)
(45)
(2)
99
84
80
93
93
Coal &
fuels
Alliance Resource ($21; ARLP)
2.70
12.6
0.7
1.2
0.5
(34)
(34)
0
99
79
74
94
89
Coal &
fuels
DCP Midstream ($28; DPM)
3.12
11.3
1.2
3.7
0.5
(29)
(31)
2
83
56
61
84
74
Oil
storage
Energy Transfer Equity ($21; ETE)
1.14
5.4
0.5
0.9
0.6
(35)
39
23
69
86
72
86
76
Oil
storage
Notes: Quadrix scores are percentile ranks, with 100 the best.  Our 12-Factor and Reranked Overall scores compare MLPs only to other MLPs.  The PEG ratio is price/earnings based on the current-year estimate, divided by the long-term growth consensus. 

 


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