Time to Give Pipelines Another Look | WSJ | AP Wealth Management

MLPs have had a rough couple of years but a litany of bad news has left valuations at attractive levels

By Spencer Jakab
Updated March 19, 2018 5:56 a.m. ET


For the past two years, investors have bought and sold shares of pipeline owners for all the wrong reasons. Now there is a chance to buy them for the right ones.

The latest blow to energy master limited partnerships came last week when a decision by regulators potentially lowered the tax benefits for the industry. The benchmark Alerian MLP Index fell by 5% on Thursday. Contrarian investors should take note.

MLPs were flying high for the first five years of the economic expansion, benefiting from the shale revolution and from yield-hungry investors who embraced their fat, seemingly reliable payouts. From the time the Federal Reserve began quantitative easing through July 2014, when oil prices peaked, the sector had a total return double that of the S&P 500.
In late 2015 and early 2016, though, investors were spooked by some reductions in distributions to unit holders and limited instances of previously sacrosanct long-term pipeline contracts being rejected by bankruptcy courts. Retail enthusiasm for the sector continued to wane as a result of last year’s tax legislation, which removed some of the appeal of entities that pass along untaxed distributions to unit holders, and by corporate governance conflicts.

Master to Disaster
Price to funds from operations


But, like much else surrounding MLPs lately, investors focused on the wrong things and missed the overall attractiveness of an industry with rising demand and valuable assets. By Friday morning, nearly every large MLP had issued a press release to give investors some sense of their exposure. Companies most exposed include Enbridge Energy Partners, Spectra Energy Partners and Williams Partners, analysts wrote.

According to Matt Sallee, senior managing director at fund manager Tortoise, the average sector hit to earnings only may be around 2% and could push some partnerships to be acquired by their corporate parents. He points out that for investors in the top income tax bracket, the net effect of corporate and personal tax changes is a wash.

Investors soured on the sector in part because the yields become less attractive as rates rise. That is likely true, but it shows investors are making the same mistake they did when they bought MLPs purely for the yield.

The biggest factor driving future returns is valuation, and the regulatory ruling succeeded in pushing MLPs to a level that has sparked past rallies. As of Friday, the index was trading at an 8% discount to the S&P 500 on the basis of price to projected funds from operations over the following year, according to FactSet. The only two occasions in the past decade that saw a similar discount, in November 2008 and February 2016, preceded rallies of 50% and 60% respectively in the index over the following six months.

Those assets may not stay this cheap for long.

Write to Spencer Jakab at spencer.jakab@wsj.com

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