How to Choose an Energy MLP

 | Jun 03, 2013 | 3:45 PM EDT  | Comments
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Friday's market action signaled at least a relative near-term weakness in the dividend stocks, which have largely led the three-year rally in stocks. The energy master limited partnerships (MLPs), boasting some of the strongest distribution yields, have also been targeted in this swoon, and have dropped significantly in the last few weeks. But not all the MLPs are created equally, and being in the right MLPs going forward is going to keep your portfolio safe without completely abandoning every stock in the sector.

The swoon in MLPs has been part of a rotation going on in stocks, as long-term interest rates in the 10-year Treasury have spiked above 2%. As bonds have dropped in value, those dividend stocks and MLPs have reacted in much the same way: The more the stocks have resembled bonds, the weaker they've been. For MLPs, the more "'bond-like" companies are those that have very static assets, with their value tethered to current distributions.

The least bond-like of the MLPs are those companies that have been pursuing new assets while old assets have been deteriorating and where the expectation is that the distribution will be rising and not static or even falling over time. In general, MLPs with the lower distributions of between 4%-5% have proven more resilient in the latest downswing. Meanwhile, the higher distribution MLPs of between 6%-8% have taken the hardest hits.

This is not a hard-and-fast rule, but let me give you two examples to clarify:

 

Source: TradeStation

 

Plains All American (PAA) is a larger market cap MLP at $19 billion and one of the most widely owned and followed. It is currently delivering a 4.1% distribution yield. Here is why it has managed better in the latest stock market swoon: It has deferred from a big distribution in favor of continued investment in new assets. PAA it has been specifically in the Bakken and also in the 95-mile extension of its existing Oklahoma pipeline. It has also continued to shed its under-performing assets, including its $190 million sale to Magellan Midstream (MMP) in February. PAA is a classic low-distribution MLP with dynamically changing assets.

 

Source: TradeStation

 

TransMontaigne (TLP) is a much smaller, far less widely covered MLP with a $608 million market cap. It is delivering an astounding 6.1% dividend but it is less dynamic in its assets, despite buying a 40% interest in the the Bostco terminal facility project from Kinder Morgan (KMP) in December of 2012. It has gained some institutional interest in the first three months of 2013, which has spiked its price from around $40 a share to slightly over $50. It has taken the latest drop in bond prices most seriously and is now trading again around $42 a share. TransMontaigne is a well-run company and will continue to pursue new assets, but the nature of its portfolio makes it more sensitive to bond market moves.

I know that this analysis may raise expectation for me to recommend my favorite "bullet-proof" master limited partnerships (MLPs). I will do that in my next column. But for today, it's important to understand what the characteristics are for more sensitive MLPs in a bond market now suddenly under pressure.

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