The oil rout has hammered just about any stock even remotely connected to the energy business, and that includes master-limited partnerships. Once the sector’s investment darling, the Alerian MLP Index tumbled 14 percent in the final quarter of 2014. But savvy investors who understand the subtle differences in MLPs can use the rout to pick up since nice bargains on these tax-advantaged, dividend-paying investments.
“There are pockets of opportunity of things that have been sold off really hard,” said Hinds Howard, director of MLP research for CBRE Clarion Securities.
The MLP structure has been used to hold everything from oil and natural gas production to pipelines, gathering systems and storage. Some are more affected than others by the more than 50 percent decline in oil prices during the past six months.
For example, investors probably want to avoid “upstream” MLPs, because their distributions are tied to actual production. The price decline is going to crimp payouts at these partnerships. Last week, for example, Linn Energy and BreitBurn Energy Partners LP both reduced the amount of cash they will distribute to investors. Citibank analysts Faisel Khan and Vikram Bagri warned that other upstream MLPs may be forced to make similar moves. Because no one knows how low the price of oil might go — it hit high a 5-year low this week — buying these MLPs is like catching a falling knife.
The so-called “midstream” MLPs, those that primarily operate pipelines, may fare better in the short term, but investors need to worry about long-term growth, Howard said.
“There aren’t going to be as many pipelines that are necessary or needed as quickly,” he said. “To the extent that you’re an MLP that was banking on organic growth, that’s going to cause problems later on. The growth is going to have to come from buying stuff rather than building stuff.”
Smaller MLPs with niche assets such as regional distribution may be attractive takeover candidates for larger partnerships looking to fill in gaps in their asset portfolios. Howard believes the midstream MLP sector will continue to grow, but at a slower rate in the next two years than it experienced in the past two.
So what should investors look for?
“Find MLPs that have growth that’s visible and dependent on something other than building infrastructure to support production growth,” Howard said.
For example, partnerships whose pipelines supply refiners have been unfairly targeted in the MLP selloff. Refineries benefit from lower crude prices, and consumer demand for gasoline and other refined fuels hasn’t dropped off. In fact, with lower pump prices, it may increase. That means refinery-linked MLPs stand to benefit. One example: Genesis Energy LP. It’s posted 11 percent year-over-year distribution growth and it’s biggest customers are refineries.
The same is true for many large, established midstream companies that collect “tolls” from their pipelines regardless of the commodity price. Units of Enterprise Products Partners LP, the biggest midstream MLP, are down 13 percent since late November, yet the company is expected to continue to grow by 5 percent to 6 percent a year, Howard said.
Another option for MLP investors looking for bargains: partnerships that are supplied by their parent companies, such as Valero Energy Partners. In most cases, these MLPs have a level of throughput that is essentially guaranteed.
The decline in oil is creating buying opportunities, but they can hard to find. The farther oil falls, the more wary investors become.
“There’s a long shopping list,” Howard said. “The problem is the list keeps going down. There’s just an aversion to energy in general.”
