Yves Siegel: Baby Boomers Attracted to MLP
Source: Brian Sylvester of
Master limited partnerships (MLPs) are growing in popularity
as baby boomers nearing retirement flock to yield. In this
exclusive interview with
The Energy Report,
Credit Suisse Managing Director and Senior Analyst Yves Siegel
targets MLPs that are still growing faster than this burgeoning
sector and dispels rumors that MLPs could be subject to new
Alerian MLP Index
Chesapeake Midstream Partners, L.P.
El Paso Pipeline Partners, L.P.
Energy Transfer Equity, L.P.
Energy Transfer Partners, L.P.
Enterprise Products Partners, L.P.
Regency Energy Partners, L.P.
Western Gas Partners, L.P.
The Energy Report:
Yves, when you last spoke with
The Energy Report
in August, you said that MLPs are viewed as good defensive
investments in times of uncertainty. Now that the economy is
starting to find its feet-growing at an annual rate of 3.8% and
adding about 250,000 jobs last month-does that mean MLPs are less
attractive than they were a year ago?
MLPs still are very attractive because investors continue to
gravitate toward yield securities in a low interest-rate
environment. Despite economic progress, there is still a lot of
uncertainty in the markets and there's still concern that
economic growth is less robust than it should be in a typical
recovery. MLPs still are quite attractive, and investors still
are looking for yield.
Why are people looking for investments that are producing
Demographics are dictating the search for yield. As baby boomers
start to retire, they are looking for vehicles with relatively
low risk, such as MLPs. Also, investors are concerned about
inflation. Typically, the distribution growth at MLPs is able to
keep investors ahead of inflation. As the population ages and its
investment time horizon shortens, there's less ability to recover
from a bad investment decision. Investors want to dial their risk
profiles down a little bit.
But even MLPs aren't without risk. Last week, the
Alerian MLP Index (NYSE:AMZ)
fell by almost 2% after the
Association of Publicly Traded Partnerships (NAPTP)
reported the Obama administration is considering a proposal to
tax pass-through entities, such as MLPs. What impact could that
have on the sector and its risks?
That created quite a stir, but actually the Obama administration
is only considering various tax proposals. No plan has been
written; in fact, it's a low probability because there's not a
whole lot of traction to tax pass-through entities. Having said
that, I think it is always a risk that what legislation giveth,
legislation can taketh away. In the late '80s, tax legislation
narrowed the scope of income that qualified for MLP status to
natural resource companies primarily. The rationale was based on
concerns about tax leakage and too many companies deciding to
become partnerships as a way to mitigate tax liability. That
legislation significantly narrowed the scope of what qualified to
be in a MLP.
A few years ago, Canada changed its tax legislation, as it
related to royalty trusts, and that spooked the market for MLPs.
Clearly, Canada was just mimicking what the U.S. had
done-narrowing the scope to qualify. Canada was concerned about
too many conversions to royalty trusts. If legislation changed,
that would have a negative impact on MLPs; but the likelihood is
very high that there will not be a change at this point in
One of the barometers for the health of MLPs is the yield spread
to 10-Year Treasuries. What's the current yield spread?
The current yield spread is around 275 basis points, or 2.75%.
MLPs, in aggregate, are trading at about a 6% yield. The 10-Year
Treasury is around 3.25%.
At the beginning of 2011, it was 382 points on a 5-year average.
It's down about 100 basis points from that. Does that demonstrate
a bit of weakness in the current market?
It actually suggests that MLPs have been strong, and the
valuations are no longer as cheap as they were at the beginning
of the year. MLPs have done well as an investment because
investors are searching for yield, and MLPs have been able to
grow their distributions. There's more demand for MLPs, so the
price has gone up. When the price goes up, the yield spread
relative to 10-Year Treasuries tightens. So, what does that mean
to me? It means that I would not characterize the MLPs as being
overpriced. I think they're more fairly priced today than they
have been over the past several years, but it's a mistake when
investors look solely at that spread. I would argue that, when
interest rates are high, the spread to the 10-Year Treasury is
Take an extreme case: If the 10-Year Treasury is yielding 8%,
investors probably need more than a 12% yield, or 400 basis
points to the 10-Year Treasury, to coax them into an alternative
investment type. However, when interest rates are lower as when
the 10-Year Treasury is down to the 3% range, then a 6% yield is
pretty attractive in my mind. It's not just the absolute
spread-it's the relative spread. Another argument in favor of
MLPs is that, as they gain prominence, investors might come to
the conclusion that they don't need 400 basis points or 4% more
to invest in them. They will feel comfortable with the
investment, so maybe all they will need is 250 basis points.
A total of 13 new MLP products launched in 2010: 7 exchange
traded funds (ETFs), 3 closed-end funds and 3 open-end funds.
Those products raised roughly $4.5 billion. Are we seeing similar
sector growth in 2011?
There are more closed-end funds. You do have folks looking at new
exchange traded notes (ETNs) and new ETFs. It speaks to the fact
that investors increasingly are looking for yield. There's
recognition that MLPs are a good place to invest and satisfy that
Let's talk about those distributions. Median distribution growth
reached a high of about 11% in 2008 before falling to 3% in 2009.
It also was around 3% in 2010. What are your projections for
We think distribution growth will continue to grow in the 4%-5%
range on average. What's driving that growth is, most
importantly, the new investments around energy infrastructure.
MLPs have been very good stewards of capital. They're investing
money well in excess of their capital costs. Those excess returns
are enabling them to raise distributions. Also, I think the base
business is growing. There's more demand for commodities and more
gasoline demand, so there will be more volume through their
pipelines. That can impact cash flow and the ability to pay
There's a bit of a feeling that there's a bottom there, too.
That type of growth rate is not sustainable, part of it has to do
with the fact that there were a number of MLP initial public
offerings in the mid 2000s. Those companies were able to grow the
distributions faster than mature companies. I think that growth
rate also included the general partners (GPs). Typically, the
publicly traded GPs can grow their distributions twice as fast as
the underlying MLP. The combination of small MLPs coming to
market and being able to grow faster and the GPs growing faster
than normal raised the distribution growth to levels (i.e., 11%)
that are now just not sustainable.
What are some names that are growing distribution growth faster
than the sector as a whole?
Right now, the companies that are showing really good growth are
Western Gas Partners, L.P. (
El Paso Pipeline Partners, L.P. (
Chesapeake Midstream Partners, L.P. (
. What those three companies have in common is that they're able
to acquire assets from parent companies that continue to be very
accretive to the underlying unitholders.
Are MLP valuations fairly relative to historic valuation metrics,
or is there still some value to be found out there?
Yes, MLPs are fairly valued relative to historic metrics. But is
there still value to be found? I think the answer to that also is
yes, because the value proposition is such that you have a 6%
average yield and distribution growth of 5%; so, all else being
equal, that would equate to a roughly 11% total return. From a
risk-reward comparison, I'd be challenged to find other
investments that could generate that kind of total return without
reaching further out on the risk spectrum.
Energy Transfer Partners, L.P. (
built the Fayetteville Express Pipeline to access the Haynesville
Shale. It spent billions of dollars to build both pipelines. Is
the company starting to reap the rewards of those
The answer is yes. The Tiger and Fayetteville Pipelines both came
onstream in January. Energy Transfer Partners has an incremental
expansion project yet to happen on the Tiger. It also made a key
$2B acquisition of Louis Dreyfus Highbridge Energy LLC's assets
as a joint venture (JV) with
Regency Energy Partners, L.P. (
. It's starting to invest in the natural gas liquids (NGL) value
chain for two purposes: 1) Its customers are drilling more
natural, rich gas, so ETP is expanding its service capabilities
to handle the NGL transfer needs of its clients; and 2) The
company believes it can get a very nice return on that
What are your ratings on Energy Transfer, Chesapeake, Western Gas
and El Paso?
We have an Outperforming rating on Energy Transfer Partners and a
12-month target price of $56. We also have an Outperform rating
on its general partner,
Energy Transfer Equity, L.P. (ETE)
, with a $47 price target. Western Gas has a $36 price target
and, formally, we don't have ratings on Chesapeake or El
Are there any other MLPs that you're excited about?
We think that
Enterprise Products Partners, L.P. (EPD)
is very strong. I would characterize Enterprise as a core holding
in the MLP space-it's the largest MLP today. It has a very strong
foothold in the NGL value chain that Energy Transfer is now
entering. It also has a very strong capital program, spending
several billions of dollars providing infrastructure in the Eagle
Ford Shale play, which is one of the most-prolific plays in the
U.S. today. We have a target price of $45 on Enterprise.
The other interesting thing about Enterprise Products Partners
is that it has steady 5% distribution growth. It has consistently
been able to grow the distribution at 5% with excess coverage.
Over the last several years, where the typical MLP business model
is to pay out all of its cash flow in the form of distributions,
EPD has paid out roughly 80% of its available cash flow and
reinvested close to $2B of it in the business. That is
Is that because most MLPs pay it all out?
Yes, with a much skinnier coverage ratio.
Do you think that more companies are likely to adopt that
strategy as time goes on?
I don't think so. The reason this is unique to EPD is the vision
of its founder, Dan Duncan, who believes that cost of capital is
very important. Enterprise was one of the first to restructure
its incentive distribution rights. Its view of managing capital
is much different than that of a lot of companies. I think the
company has the right model, but it took it a long time to get
there. I don't think other companies are going to adapt that
model anytime soon because most want to try to grow the
distribution as fast as they can to create the highest stock
price possible. From a long-term perspective, however, it's like
the tortoise and the hare argument. I think the hare is going to
win, in terms of providing the best total return over a long
In a recent interview, you said distributions should be viewed as
sacrosanct and that MLPs have to be aware that they have to grow
the distribution growth; but, at the same time, it has to be
sustainable. Can you talk about that?
I would go so far as to say that all of corporate America should
follow that policy for dividends. Distributions are an
obligation. I think it's as important a commitment as debt
service. There is an implied understanding between MLPs and
investors; that is, the MLPs will set distributions at a level
that is sustainable. That's why people are buying MLPs. It's the
belief that the distribution is safe.
What should we expect from the MLP sector throughout the rest of
I believe distribution growth will stay in the 4%-5% range. I
think investor demand for the MLPs will stay robust; I don't see
a lot of downside. I believe investors can expect a 10% or better
total return. MLPs should continue to announce a lot of projects
to develop the infrastructure necessary to tie in the new
supplies that are being generated from unconventional resources.
I don't think we're yet at the point where we're going to see a
whole lot of consolidation in the space. That's something I think
will happen, but it's probably several years away.
Are we going to continue to see more institutional ownership of
Yes. I think there will continue to be a broadening of
institutional ownership. When you think about the hurdle rates
some institutions have, especially insurance companies and
pension funds, where they need a certain return to meet their
obligations, a 6% yield and growth in distributions is pretty
close to meeting those targeted returns. So, you don't need a
whole lot of growth to satisfy those investors. It's something we
think makes a lot of sense.
Yves, thanks for chatting with us.
Energy Research Team in June 2009 to cover the MLP and natural
gas pipeline sectors. Immediately prior to joining Credit
Suisse, Siegel was a senior portfolio manager at a New York
hedge fund focused on MLPs. Prior to his buyside experience,
Siegel had established a leading sellside MLP franchise, having
spent more than 10 years at Wachovia Securities after prior
sellside engagements at Smith Barney and Lehman Brothers. He
has received both a BA and an MBA from New York University and
is a CFA charterholder.
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1) Brian Sylvester of
The Energy Report
conducted this interview. He personally and/or his family own
shares of the following companies mentioned in this interview:
2) The following companies mentioned in the interview are
The Energy Report:
Energy Transfer Partners.
3) Yves Siegel: I personally and/or my family own shares of the
following companies mentioned in this interview: Enterprise
Products Partners. I personally and/or my family am paid by the
following companies mentioned in this interview: None.
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