MLPs Continue Strong Performance

It wouldn’t be completely accurate to say midstream companies make up the MLP universe, but it is true that midstream companies make up a large majority of this sector. In many ways what happens with MLPs is a signal of how the midstream is performing. In this case, business remains strong following a period of uncertainty in the fall.
Investors have taken a more defensive approach in 2015, and this is expected to continue into at least the beginning of 2016. The ability of MLPs to increase unit payouts and meet growth targets should help the sector remain a Wall Street favorite.
“It was a rough fourth quarter and start to 2015 for MLPs, but the market has been better recently with quality names raising distributions,” John Cusick, senior research analyst at Miller/Howard Investments, told Midstream Business.
The MLP market experienced volatility because of investor uncertainty over whether MLPs active in the midstream would be able to continue their strong growth policies. These fears subsided when these companies were able to meet their distribution forecasts in the fourth quarter and again in the first quarter.

Yield growth
“It’s very important to continue to meet and raise distributions. Most long-term investors in the space are looking not only for yield, but growth of yield. If the sector were to incur a long downturn and stopped raising distributions, then yield would adjust upwards in order to account for this change,” Cusick said. He added that Miller/Howard is focused on the total return—yield plus growth—and feels positive that the MLP market will experience another typical low double-digit total return this year even with growth possibly being
slower than in past years.
“Growth may be a little less than in past years simply because of some project delays and companies being more prudent with balance sheet management. In times of volatility, coverage ratios become more important, but we think we’ll see solid returns,” Cusick said. Midstream MLPs have also worked to quell investor concerns over potential project cancellations. Though several companies have pushed projects back, so far the majority of these companies haven't canceled any projects.
Most investors understand that future distribution growth is tied to projects being built and becoming operational. From what we’ve seen, investors want to be reassured that the projects will eventually get built,” Cusick said. Many companies involved in the midstream have learned from the 2008 to 2009 downturn in energy prices. Foremost among these lessons has been the need to have more assets not directly tied to commodity exposure.

The tollbooth model
“Companies that weren’t focused on fee-based projects now are building this tollbooth model where they get paid regardless of commodity prices,” Cusick said.
He noted that Miller/Howard has taken a “follow the money” mantra by focusing on MLPs that are placing their budgets into areas where E&P companies are spending capex. These regions will be able to sustain production growth in this lower-priced commodity environment, which makes them attractive to investors.
Though seasoned MLP investors are aware of the difference between the downturn of 2008 and this current price downturn, he added that one of the possible factors in investor uncertainty may have come from new investors to the space.
“The way we look at it is that MLPs have done very well for a long time and outside of the 2008 to 2009 time period, it’s been pretty much straight up growth for the sector. Since then, there have been a lot of new investors who didn’t go through that previous downturn and may not be fully aware of the differences,” Cusick said.

Capital access
Since the overall economy has not been impacted by the distress in hydrocarbon commodities, and the MLP sector has long outpaced the overall stock market, MLPs continue to have strong access to capital. Additionally, the sector has a proven business model with a structure that lends itself to being able to develop projects since corporate taxes are passed along to investors.
“The tax advantage nature of the structure generally results in a lower cost of capital so the credit and debt markets seem to be very open to MLPs. They are placing debt at very attractive rates,” Cusick said.
Much of this year’s growth will be based off of projects that were started several years ago since it takes anywhere from 18 to 24 months for most projects to be fully developed and completed. While this is good for the MLP market this year, it could hinder growth in a few years.
“We think the MLP industry faces a changing landscape—or at least a period of recalibration—as a result of fundamental changes in the domestic upstream business,” Morgan Stanley said in a May research note. “We think lower or flat volume could delay volume growth and some midstream capex by one to two years overall, although not uniformly across projects.”
However, if commodity prices rebound quickly and producers increase their investments next year, then midstream MLPs shouldn’t see much of a dip in activity, according to Cusick.
“A lot will depend on where commodity prices are going. If producers spend 30% less than last year and that extends into next year then you’ll see projects delayed further and it could impact distribution growth in 2017 or 2018. If commodity prices rebound a little from here, we’re likely to see projects ramping up a little faster and that should support distribution in those out years,” he said.