Wulff says many MLPs are now overvalued and are paying distributions in excess of their sustainable capacity.
Most general partners are getting 50% of incremental cash flow from their properties, he says. "They are diluting ownership because they are buying properties that offer a competitive economic value at eight times cash flow, and it will pay enough of a return to get the principal back and make 6% to 8%. The limited partners are responsible for the debt. The general partner is taking an equal amount but puts up no money. In the end, the properties aren't good enough to pay both," Wulff maintains. He adds general partnership interests often are not fully reported.
Of the MLPs he covers, he doesn't recommend buying any of them and in fact recommends selling Kinder Morgan, Enbridge and GulfTerra, in part because of concerns about their payouts. A July 30 rupture in a 48-year-old pipeline between Tucson and Phoenix owned by Kinder Morgan spewed up to 10,000 gallons of gasoline on five houses under construction, and the accident might not have happened if the partnership took less money for itself and spent more on protecting the public, Wulff maintains.
However, Kinder Morgan, which owns more than 25,000 miles of pipelines that transport 2 million barrels of gasoline and other petroleum products per day, says it is highly concerned about public safety. In a prepared release, Tom Bannigan, president of KMP's products pipelines, comments, "Our priorities have been, and continue to be, to operate our pipelines safely and to provide adequate fuel supplies to our Arizona customers."
Although he thinks many MLPs should be avoided, Wulff says one oil and gas MLP, Dorchester Minerals, may be worth a look. Although he believes it has a high valuation and hasn't recommended buying it, Wulff says his analysis may not be fully recognizing Dorchester's low risk-it has no debt and owns royalty interests in some properties. It also isn't paying out any high general partnership compensation, he adds. He notes Enterprise Products Partners recently cut its GP compensation to 25%, but other MLPs have yet to follow suit.
Wulff believes royalty trusts and traditional energy stocks are better investments than MLPs. A key tool he uses to evaluate energy investments is a measure he developed, the McDep ratio, which is an entity's market cap plus debt divided by the present value of oil, gas and other businesses. More information on his analysis is available at www.mcdep.com.
Royalty trusts, some of which are based in the United States and others in Canada, also must be evaluated carefully, he says. A fundamental question is how long is the life of a royalty trust's reserves, which generate the cash flow paid to investors, he says. Also, it's important to understand where the interests lie of the company that sponsors a royalty trust, Wulff adds.
Royalty trusts he currently recommends are Canadian Oil Sands Trust, which produces oil from Canada's Alberta Oil Sands, and San Juan Basin Royalty Trust, which owns natural gas and oil fields in New Mexico's San Juan Basin.
Another fan of San Juan Basin is Jean-Marie Eveillard, manager of First Eagle Global Fund, which now owns more than $15 million worth of units and has had a position in the trust for 20 years. "We've looked at others in the past, but none of them from our own point of view was better than San Juan Basin," he says.