Mayukh Poddar, a portfolio manager at Altfest Personal Wealth Management, says that aside from Williams Partners, his firm otherwise does not have a large MLP presence. He noted that many MLPs had used leverage to fund their payouts, but he also thinks they have likely reached the end of that cycle; and Altfest doesn’t expect any more dividend cuts. “Most of them have the income now to support that dividend.”
However, he is concerned about MLPs’ exposure to interest rates, he says. Higher global rates will buffet income-generating investments like MLPs and utilities, which tend to underperform against Treasurys.
MLPs, it should be noted, are suitable only for retail, non-retirement accounts because they use leverage, are prone to generating unrelated business taxable income (UBTI) and issue K-1s. For that reason, Altfest doesn’t want to expose its investors to them. One way around that to get exposure to midstream oil is to buy companies as C corps or to use ETFs, which are already C corps. It’s also another reason the new tax laws might make an MLP’s conversion into a C corporation more attractive. (Kinder Morgan famously made this move in 2014.)
FERC Gets Involved
Jeremy Held, the senior vice president and director of research at ALPS Advisors, the advisor to the Alerian MLP ETF, said that MLPs were unfairly hurt by the Federal Energy Regulatory Commission ruling that was handed down in mid-March. The commission said it would “no longer … allow [MLP] interstate natural gas and oil pipelines to recover an income tax allowance in cost of service rates.” The commission was reacting to a court decision that said one MLP was enjoying a double recovery of income tax costs—”both an income tax allowance and a return on equity determined by the discounted cash flow methodology,” FERC said. Investors saw the ruling and quickly punished MLPs.
According to Held, however, many MLPs don’t use this methodology. The two largest MLPs in his index, Enterprise Products Partners and Magellan Midstream Partners, for instance, both came out right after the ruling and insisted that it wouldn’t affect their operations. Held says, “I think the really important takeaway … the impact is going to be very nuanced and it’s much more complicated than what the initial market reaction was. You really have to dig into the details for each MLP to see what the major impact was.”
Held says that interest rates are also less influential on MLPs in benign rate environments. MLPs, which as distribution vehicles have a lot in common with REITs, are somewhat interest rate sensitive, but Held says historically their sensitivity has depended on the whether overall interest rates are high when MLPs’ spread over Treasurys is low.
Connor Browne, a portfolio manager at Thornburg Investment Management, and Greg Mazares, an equity research analyst at the firm, say the Thornburg Value Fund is looking at companies that are free-cash-flow positive and have investment grade credit ratings showing an ability to spend within cash flow and eschew debt. The MLPs in the $1 billion fund are Enterprise Product Partners and Teekay LNG Partners, an MLP in the shipping space.
Enterprise, they say, is a leader in exporting a lot of the hydrocarbons that are produced in the U.S.—oil and a lot of the liquefied natural gas—and the company has built huge export capacity in the Houston Ship Channel, becoming, according to various sources, the nation’s largest crude exporter. Mazares says, “By being one of the early movers in energy exports and getting on that before others, you can set contract terms with companies that have demand for those services before competition comes in.” Mazares and Browne also say that it’s better not to be in an MLP with incentive distribution rights, where the MLP gives as much as 50% of the cash flow back to its parent as the cash flow ramps up. “Enterprise got rid of that structure earlier than most,” Mazares says.
Browne, like Bradshaw, says that it’s important for an MLP to be able to maintain its distribution from cash flow generated, especially in different scenarios for the commodity price. “Many of the MLPs that hurt investors were overdistributing and were dependent on raising capital by selling shares at high prices just to maintain their distribution. What we look for and what we think we have in Enterprise is a company that distributes much less of its cash flow, therefore has a lower yield than it otherwise would, which is less exciting potentially to financial advisors, but [it has] a much safer distribution.”