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By: Roger Conrad
The third quarter of 2012 was marked by a recovery in energy
prices from the lows made in May and June. The extent to which that
helps any energy producers will depend on the structure of price
hedges. And exposure to natural gas liquids prices and "frac"
spreads is something of a wild card, as these markets are much
smaller and more difficult to hedge.
By and large, however, the resilience of energy prices should
prove to be a major plus for the maintaining the pace of new energy
midstream projects, particularly in oil. Meanwhile,
continued to enjoy a very low cost of capital, for both equity and
Predictably, new equity issues during the quarter routinely
triggered short-lived selloffs for MLPs. Enterprise Products
Partners LP's (
) USD473 million offering in late September didn't do too much
damage, sending the unit price down from USD54 and change to USD53
and change. Other MLPs took more dramatic hits when they went to
market, however, including Energy Transfer Partners LP (
My view is that selling in the wake of equity issues is usually
a good time to buy an MLP, as raised funds are almost always
invested in accretive enterprises. But investors should continue to
expect this kind of action when companies come to market.
As for debt capital, Enterprise Products' debt maturing in
January 2068 currently trades at a yield to maturity of less than
4.5 percent. That's emblematic of a market that's appears still
ready, willing and able to accept any and all debt that's backed by
energy midstream assets.
Low cost of capital means even very conservative and therefore
lower margin projects can be highly lucrative. The most encouraging
thing is that most MLP managements are still not succumbing to the
temptation to relax project standards to boost revenue, or to lever
Rather, management is still locking in cash flows with long-term
contracts and keeping balance sheets relatively clean.
Even MLPs with larger amounts of debt have very low obligations
relative to their size. Enterprise Products, for example, has a
total of USD1.2 billion in bond issues maturing in 2013. That
amount, however, is equal to just 2.5 percent of the company's
market capitalization. It's covered nearly three times over by the
available credit on the company's USD3.5 billion tranche that
matures in September 2016. And it's at coupon rates between 5.65
percent and 6.375 percent, or roughly twice the yield to maturity
on Enterprise Products' 10-year debt.
The upshot is refinancing that USD1.2 billion is going to
translate into considerable savings for Enterprise Products next
year. And even if credit conditions should tighten sharply,
management still has more than enough wherewithal to retire those
obligations and refinance them later when conditions improve.
That's an extraordinarily nice position for a company to be in,
particularly when it operates a business that held revenue steady
even during 2008, when oil prices fell from well over USD150 a
barrel to barely USD30.
I fully expect solid industry conditions and low financing rates
to shine through with strong distribution coverage and continued
growth for MLPs as third-quarter numbers come in.
Several MLPs in my coverage universe did post distributable cash
flow (DCF) in the second quarter that lagged their current payouts,
namely Buckeye Partners LP (
), Kinder Morgan Energy Partners (
), Legacy Reserves LP (
), Linn Energy LLC (LINE), PVR Partners LP (PVR), Regency Energy
Partners LP (RGP) and Vanguard Natural Resources LLC (VNR).
MLPs over time must generate enough DCF to at least cover their
distributions. One quarter of inadequate coverage is excusable,
provided management has laid out a clear course for improved
coverage going forward. And that was the case for all of these MLPs
Buckeye, for example, was heavily impacted by the weather and
its impact on throughput of petroleum products.
Kinder Morgan Energy Partners' distribution increases are well
funded by energy midstream projects that began generating revenue
in the second quarter and will ramp up a lot further in the third.
The same is true for Regency and PVR, which was hit by lower
royalties from coal produced on its lands.
Legacy, Linn and Vanguard, meanwhile, were nicked by the
volatility in natural gas liquids prices in the first half of 2012,
markets which are much more difficult to hedge than oil and natural
gas. But all have new production coming on line that should more
than close any revenue gap in the second half of the year.
The key for all of these MLPs, of course, is putting up numbers
that indicate management's guidance for recovery is still on track.
Preferably, that will mean DCF coverage of better than 1-to-1 in
the third quarter and the promise of further gains ahead.
But the key will be the assumptions behind maintaining and
increasing the current distribution rate going forward, and whether
or now any have changed. For more fourth-quarter MLP picks, check