There’s an amazing song by Rihanna, about someone owing her money, that perfectly encapsulates investor sentiment last month. However, I won’t link to that song since it’s one of the most unprofessional songs to be released in recent years. Instead, please enjoy AC/DC’s Moneytalks—it captures the love the market has for more money (complete with great power chords). In other words: Money talks; BS walks.
Money Talks (But Maybe Not Loud Enough?)
In a world where the market remains ever-anxious about potential distribution cuts and occasionally goes on witch hunts for those MLPs which still have IDRs, how high of a return would you expect on MLPs bucking the trend? I present: October 2017, a case study in what-on-earth-will-it-take-to-impress-you-people?
Holly Energy Partners (HEP) announced that it would buy the incentive distribution rights (IDRs) from parent HollyFrontier Corporation (HFC) for $1.25 billion in units. As an added bonus, no doubt designed to quell fears about dilution, HFC will forgo $2.5 million of distributions on those units for each of the next twelve quarters. During October, HEP also announced its 52nd consecutive distribution increase (of 2.2% quarter over quarter) and earnings in-line with analyst expectations. HEP finished October up 2.4%, which may not initially sound like a lot, but it was the top performer in the AMZI. Given that the AMZI was down over 5% on a price return basis, HEP showed significant outperformance.
There were three MLPs which announced quarter over quarter distribution increases of more than five percent in October, but none of them had a positive month.
Let’s start with the biggest disparity. The only news from Antero Midstream Partners (AM) in October was its 6.3% distribution growth announcement, but it still finished the month down 9.0%. While the street was concerned about earnings (announced November 1st) being below expectations, it was still long-term bullish on the stock. The earnings report also indicated 1.3x coverage for the distribution. Next, Phillips 66 Partners (PSXP) raised its distribution 5.0% quarter over quarter in October, but finished the month down 4.1%. Its month was a little busier as it priced $650 million of debt at 3.75% (11-year notes) and 4.68% (28-year notes), and also announced earnings, where it reported results that analysts typically described as “solid”. Finally, Valero Energy Partners (VLP) raised its distribution 5.5% only to see the stock fall 1.7%. Maybe the reason it didn’t fall further was due to a half a billion dollar dropdown from parent Valero Energy (VLO) at an 8.5x multiple on the first twelve months of EBITDA. Earnings, again, were reported and were roughly in line with expectations.
Bull Walks, Unless You Expected It
Cutting the distribution.
Genesis Energy (GEL) cut their distribution by over 30% in October. Following the announcement, the stock only traded down 4.7%, implying that the market was at least somewhat expecting this move. Said differently, GEL traded north of a 10% yield before the announcement. (GEL was down 11.6% for the month, finishing with an 8.6% yield.) Much has already been said about this news (some of it quite cleverly), so rather than piling on, I will only say, when these dramatic cash-preserving measures are necessary, the market manages to take it in stride.
Suburban Propane Partners (SPH), a propane distribution MLP, also cut its distribution in October, but was one of the few MLPs to have positive performance during the month (rose 1.2%). Since the cut was expected, the anticipation may have been worse for the market than the actuality.
Slowing distribution growth.
Enterprise Product Partners (EPD) announced that it was slowing its distribution growth from $0.02/unit per year to $0.01/unit per year. This conservative move towards self-funding may be a long-term positive, but EPD finished October down 6.0%. When compared to SPH, it’s a bizarre contrast that a company with a long history of distribution growth that plans to continue growing the distribution significantly underperforms a company that just cut the distribution. It’s worth remembering that the market trades on future expectations, and investors may have been holding EPD to a higher standard based on the fundamentals of 2012; not the realities of 2017.
Might as well have cut.
NuStar Energy (NS) maintained its distribution in October, though its yield sitting above 12% prior to the announcement implied that investors weren’t necessarily banking on the distribution being maintained. NS units have traded down 18.0% for the month. Hindsight is 20/20, but after taking that unit price pain while maintaining the distribution, management may be wishing now that they had cut, particularly given that NS was down more than GEL, which did cut.
Investors aren’t the only people to walk away
TransCanada (TRP) canceled both its Energy East Pipeline and Eastern Mainline Pipeline projects and estimates an expected $1 billion non-cash charge in the fourth quarter. Kudos to TRP management for recognizing a sunk cost and not pursuing a project only because they’d already spent money on it. October performance? Down just 0.7%.
Except When It Doesn’t
While concerns about potential tax reform affecting MLPs have been generally put to rest, there’s another tax factor that could be impacting the space: tax loss selling. While typically the impact of this is felt in December, MLP tax loss selling is likely coming early this year as investors try to balance capital gains in other asset classes. The inflows seen into certain access vehicles could be demonstrating that there is a non-trivial amount of MLP money being moved to a better/more appropriate/temporary vehicle to avoid the wash sale rule, but still maintain exposure to the space.
It’s easy to reiterate the party line here about smart uses of cash. It’s true, the market isn’t rewarding distribution growth, and it certainly doesn’t seem to be punishing (much) companies which slow or stop growth. MLP management teams do have choices about what they’ll do with their cash flow.
While this conservative use of cash is fundamentally sound, there remains a small voice asking why would management teams cut the distribution or slow the distribution growth unless they really had no other choice? Likewise, would investors really be harvesting tax losses if they still had faith in the asset class? Current trading levels do not seem to reflect the macroeconomic environment for MLPs, but rather the technical difficulties and a continued focus on unfundamentals.