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Energy MLPs May Still Have Life

There’s room for growth in the asset class battered by low energy prices. The key: Look to the midstream and downstream segments.

As oil and natural-gas prices have rebounded, so too have energy master limited partnerships. Some analysts believe the rally has more room to run, especially for midstream and downstream MLPs, most of which survived last year’s rout in reasonable shape, as they are less sensitive to commodity prices.

“I think this is still a relatively attractive entry point for MLPs,” says E. William Stone, chief investment strategist at PNC Asset Management Group in Philadelphia. High-quality MLPs haven’t risen as much as low-quality ones, meaning the former still have attractive valuations, he says.

The Alerian MLP index has climbed 6.1 percent through June 17, following a 38.3 percent plunge last year. Compared with just 1.62 percent for the ten-year Treasury note, the Alerian index yields a whopping 7.55 percent. That hefty yield has helped produce a total return of 10.9 percent for MLPs this year.

MLPs’ collective plummet last year represented a stress test, but “MLPs have come through the other side,” Stone says. Those that needed infusions of capital were generally able to obtain it. The 30 percent advance in oil prices and 12 percent increase in natural-gas prices this year have helped. In any case, though, many midstream and downstream MLPs are less energy price sensitive than are upstream MLPs. Unlike some energy companies, “no midstream or downstream MLP has filed for Chapter 11 that I know of,” says Charles Lieberman, chief investment officer at Advisors Capital Management, a $1 billion registered investment adviser in Ridgewood, New Jersey.

Midstream MLPs consist mainly of pipeline companies. The good news: There’s plenty of oil and gas still flowing. Among the names that Stone and his colleagues favor are Magellan Midstream Partners, Enterprise Products Partners and EQT Midstream Partners.

Magellan benefits from geographical diversity in its asset base, a strong balance sheet and above-average distribution growth forecasts of 10 percent for 2016 and 8 percent for 2017, Stone says.

Enterprise has proved able to garner profits throughout its asset base, particularly on the natural-gas portion. It has grown cash flow, despite the long-term drop in energy prices.

And whereas EQT trades at higher valuation multiples than other MLPs, PNC analysts believe the premium is warranted. They forecast distribution growth of 21 percent this year and 20 percent next year and note that the company has a low debt burden.

Lieberman likes downstream MLPs too, including CrossAmerica Partners, an MLP headquartered in Allentown, Pennsylvania, that owns gas stations. Historically, gas station owners have been able to charge 15 to 20 cents more for a gallon of gas than they pay for it, regardless of oil prices. The drop of gas prices over the past two years has actually been good for gas station owners, because it has sparked record consumption, Lieberman maintains. CrossAmerica’s dividend is well covered, and unlike many other MLPs, the partnership doesn’t have large capital-spending commitments.

Dan Heckman, a national investment consultant specializing in income investments for U.S. Bank in Kansas City, Missouri, favors midstream MLPs focused on natural gas. The reduction in the number of natural-gas rigs began three to four years ago, compared with just two years ago for oil rigs, he says. And utilities’ conversion to natural gas from coal will boost demand, he says. “That should set up well for MLPs with gas transportation lines.”

To be sure, not all investment pros are enthusiastic about MLPs at the moment. “We’re underweight the sector,” says Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors in New York. Backers have claimed that midstream MLPs are insulated from fluctuation in energy prices, thanks to take-or-pay contracts requiring energy producers to pay pipeline owners regardless of how much product the pipeline takes.

But the ETF benchmarked to the Alerian MLP had an 82.5 percent correlation with oil prices from August 2014 through May 2016, Fridson says. “The idea that pipelines aren’t affected by commodity prices — well, they are if prices are low enough.” A judge ruled in March that bankrupt producer Sabine Oil & Gas Corp. could get out of take-or-pay contracts with Nordheim Eagle Ford Gathering, an affiliate of Cheniere Energy, a Houston-based natural-gas company that in December was the target of an activist shareholder move by Carl Icahn. “Payment guarantees are now in question,” Fridson says.

He isn’t bearish on the entire MLP sector. The strongest of the midstream MLPs should be fine, he says. That would include those transporting oil or gas from low-cost, conventional extraction regions, as opposed to the high-cost shale areas. And it would include MLPs that have contracts with end users, such as refiners or utilities. Fridson also sees opportunities in non-energy-sector MLPs, such as in cemeteries, amusement parks and timber.

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