Will MLPs ever take their crown back?
Up until recently, MLPs have been at the top of Alerian’s Periodic Table of Performance. Utilities currently have the highest position. As the MLP market recovers, investors are asking what kind of returns can be expected and if MLPs will return to their former glory. Unfortunately, we can’t make any promises. We can, however, discuss the total return history of the Alerian MLP Infrastructure Index (AMZI) and talk about factors that could influence returns going forward.
Looking at the performance data on the AMZI quarterly fact sheet, you can see the 10-year total return as of March 31st was 8.8%. If you were to look back at the 10-year total return of the index as of March 31, 2015, you’d see it was 14.5%. For the same time period ending March 31, 2014, it was 16.7%. The rough patch we’ve experienced has clearly had an impact. However, as we move toward recovery, it could be reasonable for investors to see 10-year double-digit total returns reappear.
First, we’ll talk about yield. As of May 31st, the yield of the AMZI was 7.7%. Since the AMZI’s launch in 2008, the average yield has been about 7%.
Next, let’s discuss the expected growth in the space. Looking at the median case from the most recent Interstate Natural Gas Association of America (INGAA) study, around $522 billion of midstream infrastructure needs to be built in the US. In the median case, growth would be about $26 billion per year. Since growth projects are typically financed 50/50 debt/equity, we could expect yearly growth of about $13 billion per year which represents around 4% of the current MLP market cap. I say “could” because there are plenty of caveats; a couple being that all of the infrastructure needed won’t be built out by MLPs and the growth won’t be evenly distributed over the 20 years.
A few other items that could affect growth are:
- Institutionalization of the MLP space. If the number of institutions making an MLP allocation increases, valuations could see a permanent shift upwards due to the increased demand—very similar to the trajectory of REITs.
- Dropdowns from corporations into the MLP space. Think Shell Midstream Partners’ (SHLX) dropdowns from Royal Dutch Shell (RDS).
- Mexico. Energy Transfer Partners (ETP), for example, has a natural gas pipeline running into Mexico.
Finally, it’s important to remember that with an investment in energy infrastructure, you’re playing the long game. This means that energy prices will swing. Cheap energy means we’ll use more of it and possibly export it. Expensive energy means we’ll drill more. The US population will grow and shift. No matter what, returns will never be guaranteed because risks will always exist. The need for energy, however, will likely never go away, even if the make-up of that energy changes from traditional hydrocarbons to renewables. In the event of a world changing break-through, we expect to see an evolution. TransCanada Corporation (TRP), for example, has already invested more than $5 billion in renewable energy sources.
Adaptability and ability to weather volatility like we’ve seen recently tells us a lot about the strength of midstream business. In the absence of promises and crystal balls, given the points made above, we do think that a revival of low double-digit 10-year returns could be a realistic scenario for investors.