MLP Analysts' Roundtable

Analysts tracking midstream master limited partnerships (MLP) are bullish on the sector and find plenty of individual MLPs to recommend. Five analysts identified 17 different MLPs, or companies serving as general partners and sponsors of MLPs, when the analysts were each asked to name five top recommendations.

The analysts say that likely total returns—combining the increase in MLP price and percentage of distributions—should be considered in making recommendations. Several themes emerged: MLPs closely associated with natural gas liquids should expect preference, at least temporarily, and those with the ability to acquire drop-down assets from their general partner are at an advantage.

Longer-term midstream companies providing new infrastructure for shale developments will do well, as they persevere during a temporary oversupply of natural gas. The analysts, in some instances, recommend the general partner, which receive incentive distribution rights from the MLP, as the better play than the MLP (See IDRs In Moderation in this issue for more information).

Analysts cautioned about blanket recommendations because, like stocks, MLP recommendations for individuals or individual clients should factor in price, risk tolerance and the time period that a MLP unit is likely to be held.

Yves Siegel, an analyst for Credit Suisse Securities LLC, explains that his recommendations have total-return projections varying from about 7% for Enterprise Products Partners LP, which is very predictable with a low risk, to about 30% for Boardwalk Pipeline Partners LP, which is largely a "value play" because its unit price in recent years is far off its previous highs after enduring "headwinds." Siegel expects the midstream MLP sector overall to have total returns of about 12%, about half from yields and the other half from distribution growth, during the next three years.

Value set

Stephen Maresca, analyst, Morgan Stanley & Co. LLC

Stephen Maresca, an analyst for Morgan Stanley & Co. LLC, cautions that with 2010 and 2011 outperformance of midstream energy stocks and MLPs, many stocks are trading at or near highs, making this much more of a stock picker's sector going forward.

"Stock valuations in the marketplace are differentiating between companies that have assets in growing oil and liquids plays versus those that are in less desirable areas, have weak balance sheets, or will struggle to execute," he says.

Jason Stevens, an analyst with Morningstar Inc., says, "Overall, we view MLPs as fairly valued. There are no screaming buys in the space right now, in our view. However, we think MLPs remain on track to post distribution growth of roughly 5% a year, on average, over the next five years. Combine that with yields near 6% and MLPs offer very attractive total return prospects."

He believes that MLPs will continue to lead the market in new capital raises, with debt and equity issuance exceeding $13 billion so far this year, demonstrating continued investor interest in the space.

"We think this interest is well-deserved. As E&Ps scramble to shift production towards oil and rich gas, one of the key limiting factors is infrastructure, and MLPs are doing everything they can to put new steel in the ground," says Stevens. "Organic spending, rather than acquisitions, is the core driver of MLPs' growth, and we think current spending levels are here to stay at least for the next three to five years."

Core holdings

Siegel, John Cusick, an analyst for Wunderlich Securities Inc. and TJ Schultz, an analyst for RBC Capital Markets, each used the phrase "core holding,"when praising Enterprise Products Partners.

"Core holding is Wall-Street speak for an asset that you should own and hold, and consider as an anchor, or integral part of a portfolio," says Siegel, noting that Enterprise has a "winning formula." During the past two years, Enterprise, which is now the largest MLP by capitalization, has completed $3 billion of expansion projects on time and about 10% under budget.

Its average debt maturity is 11 years with an average interest rate of 5.5%, and its cost of equity is low because it has no general partner incentive distribution rights (IDRs). Enterprise has raised its distribution to unitholders each quarter for the past 30 quarters and during the past 16 quarters it has raised its distribution by a little more than 5% each quarter.

With a market capitalization of about $44.8 billion, Enterprise, after "spectacular" growth (total return of more than 180% for the past three years), trades at a premium valuation to its MLP peers, Siegel says. "The premium is warranted in our view given Enterprise's low risk profile, conservative approach to managing growth and its unparalleled asset footprint."

The per unit price of Enterprise, as of the close of trading on March 30, the final day of first-quarter 2012, was $50.47, whereas Boardwalk Pipeline, for example, traded at $26.46, far off its high of $34.08 recorded in October 2010.

Cusick says, "Enterprise Products offers solid distribution growth, strong balance sheet integrity, expanding operations through organic opportunities and potential acquisitions, and a top-line management team. Combining all of these factors results in a partnership that we believe should be owned by investors seeking a high-quality investment. The partnership should continue to increase its distribution over the next several years as its strong slate of organic growth projects pushes cash flow higher. We believe the balance sheet and estimated coverage ratios demonstrate that the partnership is financially strong."

Schultz says he expects the partnership may announce plans to accelerate its already-solid distribution growth by the end of 2012. "Enterprise is well positioned to capitalize on the need for natural gas liquids (NGL) solutions and touches all parts of the NGL value chain, with projects currently being developed for NGL transportation, storage and fractionation. Enterprise also has a large presence within crude oil logistics and will reverse the Seaway Pipeline this year," he says.

Stevens adds, "Before the liquids boom really got started, Enterprise was already the dominant player, and has parlayed its expertise and assets into phenomenal growth. We think that growth is set to continue, as evidenced by recent announcements of a seventh and eighth fractionation train at Mount Belvieu and more than $6 billion in other projects underway."

Best distributions

Maresca, Schultz and Stevens each view MarkWest Energy Partners LP favorably. Maresca says MarkWest has strong leverage to the Marcellus and Utica shales and multi-year fee-based agreements with top producers in those regions to gather, process and fractionate gas and liquids.

"With $500 million to $1 billion in major expansions planned and initial projects already in place for the Utica, MarkWest appears well positioned for a multi-year buildout and we believe strong multi-year cash flow growth of 20% or more to go along with a 5.3% yield," Maresca says.

"I believe MarkWest will continue to deliver some of the best distribution growth in the space, 17% year-over-year most recently. This growth is underpinned by the market-leading position in the liquids-rich portion of the Marcellus shale and an early-mover advantage in the burgeoning Utica shale," says Schultz. "MarkWest is the blueprint for MLPs that seek an advantage of being early in a play, which allows for attractive organic growth around an established footprint."

Stevens adds that Markwest's partnering with The Energy & Minerals Group, a management company for a series of private-equity funds, in the Marcellus has been a tremendous boon for MarkWest, and now the two are working together to build out Utica infrastructure.

"We think this is a savvy move for MarkWest. Already Chesapeake is planning to build rich-gas gathering, processing and storage that will tie into MarkWest's planned Harrison County fractionation and marketing hub," he says.

Meanwhile, Siegel likes Chesapeake Midstream Partners LP, saying it is a god example of an MLP's potential when it is a recipient of high-quality assets from its general partner, Chesapeake Corp., a leading independent E&P company.

The MLP has right-of-first-offer to acquire infrastructure from Chesapeake Corp. Also, Chesapeake Corp. is aggressive, allowing the MLP to be conservative and well positioned for fee-based volume, largely through service to Chesapeake Corp., as well as drop-down acquisitions.

Cusick says, "We believe Chesapeake Midstream has the potential for above-average distribution growth during the next several years. Based on our distribution estimates, growth would be 16% in 2012 and 12% in 2013. We believe Chesapeake Midstream is a good investment for several reasons. It has a general partner with strong midstream assets. It has a fixed-fee structure with guaranteed volumes. It has potential for above-average distribution growth over the next several years. And it should remain in the low-distribution splits over the near term."

Shale plays

Jason Stevens, analyst, Morningstar Inc.

Copano Energy LLC was picked by Maresca and Schultz as a winner. Maresca says, "We expect 2012 will be a year where Copano begins growing its distribution payout to unitholders as new Eagle Ford projects add materially to cash flow. Copano has identified $300 million in high return investment capital for 2012, including $110 million on its Houston cryogenic processing expansion and $100 million for its Eagle Ford joint venture. With a roughly 6.5% trading yield, Copano is undervalued relative to its opportunity set."

Schultz says he too expects Copano's distribution growth to resume in 2012 as it begins to capitalize on its solid footprint in the Eagle Ford shale. "I believe this footprint will allow for additional organic projects in and around current infrastructure in place, which can deliver strong cash flow growth for the next several years. The current yield is a discount to the group," he says.

Targa Resource Partners LP's trading ticket symbol is NGLS, which says it all about its focus and why it is currently being recommended, Siegel says. Targa has a strong and proven management team with a very disciplined approach to deploying capital. Also, Siegel notes that its general partner is Targa Resources Corp., which because of its corporate structure can attract some institutional investors that might otherwise be constrained from owning MLPs.

Schultz views Targa Resources Partners as ideally positioned along the NGL value chain, with assets in favorable basins and a growing footprint at Mont Belvieu. "I believe Targa can deliver above average distribution growth for the next several years as it acts on a large backlog of organic projects, including a world-grade propane export facility."

Elsewhere, Williams Partners LP and the family of Williams Cos. drew praise from the analysts because of their value across the midstream value chain. Stevens picks Williams Partners noting that it has been betting big on the Marcellus.

"We think the aggressive buyout and buildout of gathering, processing, and long-haul transportation assets has helped the partnership create a dominant presence in the region. What we really like is the integration of midstream and pipelines that allows Williams Partners to collect economic rents across the midstream value chain," he says.

The MLP's general partner, Williams Cos., was the pick of Maresca, saying that company "will be a beneficiary of increased long-term demand in natural gas and increased needs for gas liquids infrastructure and gas processing. The company's recent acquisition of Caiman Energy LLC provides an entry into the liquids-rich area of the Marcellus shale, and its newly announced Utica joint venture adds another growth platform not yet priced into shares. We expect Williams Cos. will exhibit strong 23% earnings growth during the next three years, along with 20% dividend growth underpinned by high-return growth projects in the northeast and in its Canadian and olefins segment. Trading at a forward 4.2% dividend yield, we see over 20% total return on the stock within the next 12 months."

Drop down story

Yves Siegel, analyst, Credit Suisse Securities LLC

Siegel explained his picks of DCP Midstream Partners LP and Boardwalk. DCP is another drop down story as the MLP's general partner and sponsor, DCP Midstream LLC, equally owned by Spectra Energy Corp., and ConocoPhillips, is one of the largest midstream companies in the U.S. It has assets that can and will be sold to DCP Midstream Partners over time, which resumed distribution growth in fourth-quarter 2010.

Boardwalk has been oversold and its price is too low relative to its value, Siegel says. At one point, Boardwalk was faced with unfavorable contract rollovers. Now, through recent acquisitions, it is expanding its presence as a midstream company rather than just a pipeline company, Siegel says.

An overall supply of natural gas reduced its ancillary profit opportunities from storage and park-and-loan services, but when gas demand picks up and prices increase, Boardwalk will be in position to perform. Siegel adds that Boardwalk's president, Stan Horton, hired in May 2011, has the breadth of experiences across energy sectors that will be helpful in returning the price to previously attained highs.

As his other favored names, Cusick picks Plains All American Pipeline LP, Tesoro Corp. and Magellan Midstream Partners LP.

"Plains offers a history of a quality, well-run partnership that has had good distribution growth and a strong management team. With estimated 2012 distribution growth of 7.6% and a current yield of 5%, the total return would be 12.8%. Over the past several months, Plains declared a higher fourth-quarter distribution, announced acquisitions totaling $2.4 billion, and released its 2012 EBITDA outlook," he says.

"The partnership also reiterated its goal of increasing the distribution between 8% and 9% in 2012. Plains continues to announce expansion projects, including a pipeline to serve the Mississippian Lime crude-oil production area. We believe the partnership is also well positioned to make acquisitions. We believe these factors make Plains an attractive investment."

Regarding Tesoro, he believes the company will be able to grow its operations through drop-down acquisitions and could benefit from Tesoro Corp.'s desire to expand its logistics asset base.

"We believe Tesoro's distribution growth should be solid during the next several years, including estimated 2013 growth at 16.8%. The total return profile continues to look strong. Combining the current yield of 4.3%, and projected 2013 distribution growth of 16.8%, results in a total return of 21.1%. Our forecast for distribution growth could prove conservative if the partnership were to undertake further drop-down acquisitions from its parent."

John Cusick, analyst, Wunderlich Securities Inc.

Cusick says, "Magellan's distribution growth during the next several years should be strong at an estimated 8.5% in 2012 and 8.3% in 2013. The balance sheet and estimated coverage ratios demonstrate that the partnership is financially strong. Combining the current yield of 4.5%, and estimated 2012 distribution growth of 8.5%, results in a total return potential of 13%. We would continue to hold Magellan's units for the total return potential."

Additional favorite picks

Additional favorite picks for Stevens are Energy Transfer Partners LP and Kinder Morgan. "As the dust settles from the Southern Union merger and Energy Transfer Partners finally resumes distribution growth, likely in 2013, we think Energy Transfer Equity will be able to ramp up double-digit distribution growth quickly, and future drop downs will help provide visibility for continued cash flow growth."

Regarding Kinder Morgan Management, he says, "Still the most attractive way to play Kinder Morgan, in our view, Kinder Morgan Management has traded at a persistent discount to its MLP twin, Kinder Morgan Energy Partners LP, despite enjoying identical underlying economics. We think Kinder is poised for growth this year, thanks to its tertiary oil production, gas pipeline investments and likely drop downs from the El Paso acquisition."

Schultz likes Genesis Energy LP for its commitment to annual 10% to 11% distribution growth, which is viewed as sustainable for the next several years as it finds creative solutions within crude oil logistics.

"Genesis has a growing truck and barge fleet, as well as oil pipeline infrastructure and new rail loading and unloading facilities. Genesis also has a sizable presence in the Gulf of Mexico, which I believe was purchased at trough valuations, and will deliver growing volumes as deepwater drilling accelerates."

Maresca also likes Oneok Inc. and Atlas Energy LP. Oneok Partners LP is one of the largest MLPs and among its assets is one of the nation's premiere NGLs systems, connecting supply in the Midcontinent and Rocky Mountain regions with key market centers, he says.

"We remain constructive on Oneok Inc., given its unique exposure to the Bakken shale in North Dakota, where we see possibly another 400,000 barrels per day of increased oil production. The company has strong financial flexibility with a 6% free cash flow yield. With $2 billion to $3 billion in capital projects in the Midcontinent region focused on new pipelines and processing, we believe the stock does not reflect the 20% dividend growth for each of the next two years."

Regarding Atlas Energy, Maresca says the company will benefit from its general partner interest in Atlas Pipeline Partners LP and Atlas Resource Partners LP, two of the fastest growing MLPs, with assets in West Texas and Oklahoma.

"Its newly spun off stock, Atlas Resource Partners, creates a second growth platform, where upside exists as acquisitions are made in gas and oil proved reserves. We believe Atlas Energy LP has the capability to double its cash distribution payout to shareholders within the next 12 to 18 months."

Overall outlook

TJ Schultz, analyst, RBC Capital Markets

"The development of the U.S. shale plays has dictated large infrastructure investment, and the MLP space is benefiting," says Schultz. "Organic project backlogs are robust, and the positive return characteristics of these projects are allowing for improving growth profiles within the group. From a technical standpoint, I believe that the Fed's outlook for lower interest rates over a longer period of time will continue to position MLPs as an attractive yield alternative."

Cusick agrees, saying, "The MLP sector has consistently outperformed the broader market, as evidenced by the Alerian Index's higher returns in eight of the last 10 years compared with the S&P 500. We believe investors will continue to put money into the sector as they seek cash flow in the form of distributions. We continue to believe that most investors look to MLPs primarily for cash flow rather than for capital appreciation. We are looking for a 5.5% average increase in distributions in 2012 from our coverage universe. This compares with an expected increase of 6.5% in 2011."

Cusick believes that, because MLPs create the core infrastructure to transport, process, and store energy, the sector will remain robust as the Eagle Ford, Bakken, Marcellus, Barnett and Utica developments continue to increase in importance for domestic energy production.

Maresca concludes that,while acquisitions are becoming a more expensive source of growth for midstream companies and MLPs, given higher purchase multiples, organic growth returns have been increasing to 20% returns on capital.

"In addition, visibility for increased earnings has been boosted as the oil and gas energy shale revolution is causing a major need for a multi-year secular infrastructure build. We believe close to $70 billion will be spent in North America on energy infrastructure during the next three years, driving an acceleration in earnings and cash flow from 4% to 6% up to 8% to 10%, which we think is sustainable. Many large-cap stocks are identifying sustainable growth strategies, proving that size may not be the growth burden that the market previously thought.