Income Partners

10/10/2016


If you had put $10,000 into the companies in the Alerian MLP Index 20 years ago, then reinvested dividends, and made changes every time the index did, your investment would be worth more than $113,000. That same $10,000 invested in the S&P 500 Index would have grown to $45,796 — a respectable annualized return of 7.9% but nowhere near the 12.9% master limited partnerships (MLPs) delivered.

The disparity in returns is staggering, but it doesn't make MLPs better investments than traditional large-cap stocks today. MLPs have lagged the S&P 500 over the last five years, returning 27% versus 113% for the large-cap index. As a group, MLPs have mediocre fundamentals, averaging Quadrix Overall scores of 47. That said, these investments may make sense for you. Just make sure you know what you're getting into. To learn more about MLPs and how they operate, visit www.DowTheory.com/Go/MLP.

Most MLPs operate in the energy sector, which in part explains their disappointing returns in recent years. However, energy exposure cuts both ways. When the outlook for commodity prices or energy stocks improves, you can expect MLPs to benefit along with the rest of the sector.

We appreciate the appeal of MLPs, which are known for their rich dividends. The story at right lays out four reasons to own MLPs — then follows up with four reasons not to go overboard. Our buy lists feature one MLP, EQT Midstream Partners ($76; EQM). Also, we do recommend three MLPs as part of our Top 15 Utilities portfolio (www.DowTheory.com/Go/Top15) — EQT Midstream, CONE Midstream Partners ($19; CNNX), and Star Gas Partners ($10; SGU).

Investors interested in MLPs should check out our Alternative Income Watch List (www.DowTheory.com/Go/Alt), which provides A (above average), B (average), and C (below average) ratings on 42 MLPs. Below we present our Top 10 MLPs, with two caveats:

1) For the most part, we compare the appeal of MLPs to other MLPs, not the broad market. As such, an A (above average) rating doesn't mean the same as a similar rating for common stocks, just that the MLP is better than its typical peer.

2) Other than EQT Midstream, none of these MLPs warrant a Buy rating in Dow Theory Forecasts, so don't sell a quality stock to purchase any of them. Even A-rated MLPs usually have too many warts, while some of the strongest are too small for the newsletter.

OUR FAVORITE MLPs
Over the last 20 years, the Alerian MLP Index has delivered a total return of 1,036%, nearly triple the S&P 500 Index's 358%. However, the S&P 500 outperformed the MLP index by a factor of four over the last five years.
Div.
Yield
(%)
Market
Value
($Bil.)
------------- Quadrix Scores -------------
Company (Price; Ticker)
Value
Overall
12-
Factor
Reranked
Overall
Industry
Boardwalk Pipeline
Ptnrs. ($17; BWP)
2.3
4.3
86
90
66
86
Oil  storage
Ciner Resources
($31; CINR)
7.3
0.6
85
82
90
88
Chemicals
CONE Midstream Ptnrs.
($19; CNNX)
5.3
1.1
89
100
48
100
Oil storage
EQT Midstream Ptnrs.
($76; EQM)
4.1
6.0
80
98
74
98
Oil storage
Holly Energy Ptnrs.
($34; HEP)
6.9
2.0
63
80
80
79
Oil storage
Phillips 66 Ptnrs.
($48; PSXP)
4.2
4.3
43
85
72
80
Oil storage
Star Gas Ptnrs.
($10; SGU)
4.3
0.5
85
78
87
81
Gas utilities
Tallgrass Energy Ptnrs.
($48; TEP)
6.3
3.5
72
90
82
93
Oil storage
Tesoro Logistics
($48; TLLP)
7.1
4.5
70
83
84
83
Oil storage
Valero Energy Ptnrs.
($43; VLP)
3.4
2.8
53
77
50
79
Oil storage
Watch List average *
6.9
7.9
57
54
60
57
MLP average **
6.7
3.9
56
47
50
50
Notes: Quadrix scores are percentile ranks, with 100 the best.   NM Not meaningful because of a lack of history. * Average includes all 42 of our covered MLPs, not just the ones on this table.   ** Includes all 108 MLPs in our Quadrix universe.

Three of our favorite MLPs are reviewed below, including CONE, which is being added to our Top 15 Utilities portfolio, replacing Spectra Energy Partners ($42; SEP).

Ciner Resources ($31; CINR), one of the world's largest producers of natural soda ash, earns a Buy rating in our sister newsletter, Upside, which focuses on small-cap stocks. Soda ash is used to produce glass, chemicals, and detergents — end markets not overly sensitive to changes in energy prices. While the average selling price for soda ash is falling, Ciner is partially offsetting that weakness with higher volumes; the company set new production records in the June quarter and expects continued gains in the second half of the year.

The shares have returned 48% so far this year yet remain attractively valued. Ciner earns a Quadrix Value score of 85 and trades at just 14 times projected current-year earnings, 20% below the median commodity-chemical company. Ciner also trades at a substantial discount to the industry median on price/book, price/operating cash flow, and enterprise ratio. Ciner yields 7.3%.


CONE Midstream Partners ($19; CNNX) earns an Overall score of 100, the only MLP in our Quadrix universe to rank that high. CONE operates natural-gas pipelines and gathering assets in the Marcellus Shale formation in Pennsylvania and West Virginia. In the first half of the year, CONE's distributable cash flow (our preferred metric to assess MLPs' operating performance) jumped 66%. In August, the company boosted its full-year profit target.

An appealing blend of strong growth and aggressive cost cuts (throughput volumes up 51% and unit operating costs net of power down 40% in the June quarter), bode well for future growth. In the wake of CONE's August guidance, the profit consensus rose, now calling for per-share-profit growth of 27% this year. CONE yields 5.3%. The quarterly dividend paid in August represented a 4% increase from the May dividend and a 15% boost from the same time a year ago. CONE is an Upside Buy, and now a member of our Top 15 Utilities portfolio.


EQT Midstream Partners ($76; EQM), the only MLP on the Forecasts' buy lists, earns an Overall score of 98, tied for second-best in the MLP group and 12 points higher than the best scorer in the S&P 1500 energy sector. The company, which operates a network of pipelines and storage facilities in the Appalachian Mountains, grew sales 19%, per-share profits 18%, and distributable cash flow 44% over the last year. EQT Midstream yields 4.1%. The quarterly dividend has risen 22% over the last year and more than doubled over the last three years.

In July, the company raised its distributable-cash-flow projection to a range of $495 million to $505 million for the year, up 22% to 24% from 2015 levels. EQT Midstream is fairly well insulated from not only energy prices, but volumes. In the second quarter, 82% of revenue came from reservation fees. The MLP is a Buy and a Long-Term Buy, and also a component of our Top 15 Utilities portfolio.

On the outs

Spectra Energy Partners' ($42; SEP) unit price and profit estimates have trended lower since the company reported lower-than-expected earnings for the June quarter. Last month's deal by Enbridge ($43; ENB) to purchase Spectra's parent company has sparked speculation that Enbridge may use the MLP as a vehicle to raise cash. With the consensus projecting profit declines and uncertainty still hanging over Spectra, we're dropping it from our Top 15 Utilities portfolio.


Four reasons

To own MLPs

1) Fat yields. On average, the MLPs in our Quadrix research universe yield 6.8%. They can afford these yields because their partnership structure allows them to avoid taxation at the corporate level, leaving a lot more cash available for distribution than the typical stock.

2) Consistent income. While MLPs are not immune to economic or market forces, most operate in midstream energy businesses, such as pipelines or storage, which tend to produce cash flows less sensitive to energy prices than most energy stocks. Most MLPs regularly boost their payouts. Of the 72 MLPs with five years of dividend history, 54 (75%) have grown their payout during that period. Those 72 MLPs averaged annualized dividend growth of 14%.

3) Diversification. MLPs tend to travel a different path than the broad market, and even deviate substantially from the energy sector. Over the last 20 years, the Alerian MLP Index's monthly returns have a 40% correlation with the S&P 500's, which suggests that only about 40% of each index's movement can be explained by the action of the other index. In contrast, the S&P 500 Industrial Sector Index is 90% correlated with the broad index.

4) Commodity exposure. While MLPs don't trade or behave exactly like commodities, some investors view the partnerships as a back-door strategy for playing oil and gas demand.

 

Not to own too many MLPs

1) Sector concentration. Of the 108 MLPs in our research universe, 74% (80 companies) operate in the energy sector. Those energy MLPs account for 86% of the group's total stock-market capitalization. We would advise most investors to keep less than 15% of their stock portfolios in energy (our Buy List has just 3%), and no more than half of that energy exposure in MLPs.

2) Quadrix scores. As a group, MLPs earn subpar ranks in our Quadrix stock-rating system. The average MLP in Quadrix scores 47 Overall and just 38 in Momentum.

3) Tax complications. The same corporate structure that allows MLPs to avoid corporate income taxes makes owning these securities more complicated for investors. If you own an MLP, at tax time you'll receive a Form K-1, which will help you determine how to pay taxes on your distributions. While the rules are too arcane to fully explain here, much of the income from MLPs is treated as a return of capital, reducing the cost basis of the partnership units.

4) Atypical analysis. While MLPs report net income like other companies, it isn't the best way to measure their performance. To assess their operating results, MLPs consider distributable cash flow (DCF), which reflects the cash available for payment to unitholders after payments to the general partner. Analysts use DCF to assess growth, as well as distribution coverage ratios and other operating metrics.


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