#$epd

[valuentumbrian]

Just How "Messed Up" Is the MLP Structure?

Image Sources: Simon Cunningham, Images Money, Trading View. No alteration has been performed on the pictures.

The financial engineering of the MLP business model is shocking.

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By Brian Nelson, CFA

(A version of this article appeared on www.valuentum.com August 2015.)

Many dismiss economic factors when it comes to analyzing equities, and that may be fair, but in no time in history have interest rates been more important to the future prices of most US equities, in our view. The relationship between risk-free assets such as the 10-year Treasury bill and equity income-growth vehicles, namely high-dividend payers, may be the lynchpin to the sustainability of this bull market. If high-yielding equities begin to crack, they may take the remainder of US equities with them. Some of these lofty dividend yields aren’t what we call organically-derived ones, meaning they aren’t paid out as a portion of earnings or traditional free cash flow (cash flow from operations less all capital spending).

What we’re trying to say is that the fall-out from the Financial Crisis has not been avoided but only delayed, and we’re growing more and more concerned that the real repercussions are drawing nigh. If you recall, many retirees were punished significantly during the 2008-2009 period. Some opted to reduce exposure to equities, perhaps entirely, absorbing the corresponding capital losses to their treasured savings. To make up for the shortfall and the derailment of their retirement plans, today, retirees and near-retirees are now reaching for unsustainable distribution yields to make up for the reduced capital bases, and Wall Street is doing all that it can to offer as many options as it can. Where there is a financial need, it seems as though Wall Street can financially-engineer it.

And they have.

Many of the share prices of high-dividend-yielders that retirees and near-retirees have come to count on for critical income needs are, in our view, propped up by artificial valuation paradigms surrounding their financially-engineered dividends, which are supported by ongoing debt and equity issuance. Financially-engineered dividends are ones that are supported by the financing section of the cash flow statement, meaning that the operating section of the cash flow statement isn’t large enough to offset both the cash drain of the investing section and dividends from the financing section. In today’s market, share prices of these entities are receiving substantial “yield support” on what we would describe as artificial dividends, instead of being valued on the basis of their underlying operations.

If asked, Wall Street may contend that their share prices may hold as long as the threat of rising interest rates remains subdued. What can go wrong? A lot, in our opinion.

Once the relationship between yields on risk-free (Treasury) assets and yields on risky assets (dividend-paying stocks) crosses, we posit that the artificial “yield support” on companies with financially-engineered dividends will inevitably fade, and their prices will converge to more reasonable valuations that are based on actual core operating enterprise free cash flow. What we think Wall Street wasn’t expecting was that the impact of collapsing energy resource pricing on the health of financially-engineered payouts in the energy sector may be an equivalent catalyst as rising interest rates themselves.

How we interpret the financial engineering that’s proliferating across the MLP space may surprise you. Let’s try this example, using Kinder Morgan's (KMI) financials from 2015. We know that Kinder Morgan is not an MLP and the financials used are stale, but neither matter in illustrating the point we're making (we're using Kinder Morgan in this example because it is among the most well known entities, the original poster child for the MLP business model). Said differently, the following example is purely hypothetical and for educational purposes only, but let’s explain, for example, how Apple (AAPL) can effectively financially engineer a completely new “Kinder Morgan”, or create ~$75 billion in incremental equity value or more, using less than 5% of Apple’s current balance sheet, or arguably with nothing at all.

Have I got your attention now?

First, let’s cover some financials. Kinder Morgan, the largest energy infrastructure company in North America, is on pace to generate ~$4.5 billion in “distributable cash flow” in 2015. Traditional free cash flow, however, will be substantially less than "distributable cash flow" during the year given growth capital investments that are necessary to drive future increases in net income, a component of future "distributable cash flow." Let’s assume that Kinder Morgan’s “distributable cash flow” will advance at a ~10% clip over the next few years, in line with management’s expectation for the pace of dividend growth over the same time frame. Kinder Morgan’s enterprise value is currently ~$120 billion, consisting of about $75 billion in equity and $45 billion in debt.

Apple holds over $200 billion in cash, cash equivalents and marketable securities on its balance sheet, as of June 27, 2015. For illustration purposes, let’s have Apple create a corporation called iNewCorp, in which it sets up a partnership agreement by which Apple contributes ~$4.5 billion, more or less, in cash to iNewCorp per annum in exchange for 100% ownership of iNewCorp.

The agreement stipulates no minimum distributable-cash-flow to dividends-paid ratio, meaning that dividends can exceed Apple's cash contributions at any time, which equivalently happens periodically across the master-limited-partnership arena when dividends exceed distributable cash flow in certain periods. From a baseline of ~$4.5 billion, let’s also assume that iNewCorp plans to increase dividends to its future shareholders by 10% each year through 2020 and by a more-reasonable growth rate after that.

The initial ~$4.5 billion “start-up” obligation could easily be covered by Apple, an entity with $200 billion on the books and one that has generated ~$68 billion in cash flow from operations during the nine months ending June 27. Apple can cover the initial ~$4.5 billion obligation 40+ times over with cash on the balance sheet and 15+ times over with nine-months-worth of cash from operations.

Let’s now assume that Apple guarantees iNewCorp’s growing dividend stream and any and all of iNewCorp’s debts, thereby giving iNewCorp an investment-grade credit rating. With such an investment-grade rating, iNewCorp then borrows ~$45 billion against the future cash flow stream that is implicitly backed by Apple.

If you think this is good thus far, it gets better.

iNewCorp then uses this $45 billion in newly-raised debt to backstop its very own future dividend payments to its very own future shareholders. With the newly-raised debt alone, iNewCorp would then be able to cover growing dividends to its future shareholders for ~5-10 years depending on the growth rate, without any future Apple cash contributions.

Apple now IPO’s iNewCorp.

iNewCorp can now raise equity on the open market such that, with its newly-raised debt, the corporate is now able to fund its entire growing dividend stream via external capital-raising efforts, maybe on a 50%/50% equity/debt split if it wants to. Said differently, iNewCorp can fund its entire future and growing dividend stream purely from financing activities.

Under this scenario, to sustain iNewCorp's dividend, Apple itself would not have to pay any more ongoing cash to iNewCorp after the initial ~$4.5 billion outlay. Since there is no minimum distributable-cash-flow to dividends-paid mandate within this particular partnership agreement, Apple would only have to stand as a backdrop and guarantee the newly-created entity’s future dividends and debt load. The external financing markets are sustaining the dividend.

What Apple has done in this example is financially engineer the future dividend stream and capital structure of a new “Kinder Morgan,” which we have called iNewCorp, and it has done so with effectively no capital at all. Apple is just standing behind iNewCorp reinforcing its investment-grade borrowing capacity, which supports the dividend that supports the equity price, which provides incremental equity capital that can also be used to support iNewCorp's dividend, and so on.

On the basis of the then (but now hypothetical) enterprise value of the actual Kinder Morgan, iNewCorp should theoretically fetch an enterprise value of at least $120 billion, which would be all equity in iNewCorp’s case, until borrowings are distributed to iNewCorp’s shareholders as dividends. If dividends should happen to be paid directly from newly-issued equity, then there’s no reason to believe iNewCorp’s equity wouldn’t hold a ~$120 billion equity price, all else equal (at least in this market).

There's more that meets the eye, however.

Kinder Morgan then (but now hypothetically) traded at a price to distributable cash flow ratio of ~16.5 times (a ~6% distribution yield), and some may argue the enterprise value and equity market capitalization of iNewCorp should theoretically be higher than Kinder Morgan's. After all, Kinder Morgan requires growth capital to fuel future net income and dividend growth and has exposure to commodity price shifts and other operating risks, while iNewCorp does not. Apple's newly-created corporation is pure and growing cash.

It's our contention that iNewCorp should be the one to fetch a ~16.5 times P/DCF multiple (~6% distribution yield), while Kinder Morgan's P/DCF should be substantially lower given commodity and operating risks as well as the massive growth capital that is required to drive future net income expansion. In the example of iNewCorp, valuing different equities with varying growth capital outlays and commodity/operating risks on a standardized P/DCF ratio is fraught with risks. It's widely known, for example, that relative valuation techniques are exposed to the hazards of systematic overvaluation.  

In this hypothetical example, with less than 5% of its balance sheet or with perhaps nothing at all, Apple has created in iNewCorp ~$120 billion in incremental equity value, or a ~20% boost to Apple’s entire market capitalization (Apple would have received the proceeds from the IPO of iNewCorp or retained an ownership stake). That's certainly a needle-mover for one of the largest companies in the world.

One may even say that Apple can easily cover an arrangement like this many times over. If you believe in the financial engineering above, then theoretically Apple can create trillions of equity capitalization repeating this over and over again. Apple’s balance sheet and cash flow generation are assets much like the pipelines in the ground are assets.

There is a very good reason, in our view, why dividends should be paid out of traditional free cash flow (cash from operations less all capital spending) or earnings, as anything else is textbook financial engineering. We’ll soon find out whose been “swimming naked” once the tide goes out of this energy cycle, which may be sooner than later (yes, it's now completely over). Wall Street wasn’t prepared for the collapse in energy resource pricing in 2015, and we doubt they will be when the next downdraft comes.

We’re sticking with companies that have organically-derived dividends, and we're not omitting varying growth capital outlays and operating risks from our analysis. From our perspective, the financial engineering is pretty alarming.

Pipelines - Oil & Gas: BPL, BWP, DPM, ENB, EPD, ETP, EVEP, HEP, KMI, MMP, NS, OKS, PAA, SE, SEP, WES

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This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice. For more information about Valuentum and the products and services it offers, please contact us at [email protected].

[speedycalls]

$EPD 27 Calls BUYING Activity expiring on 19th Aug, Vol 3161 

[lawrencelewitinn-blog]

Never mind the Brexit — here are energy stocks still worth buying: Portfolio manager

Oil prices have been volatile since the Brexit vote, but there may be opportunities in the energy space, according to one portfolio manager.

Robert Thummel, portfolio manager at Tortoise Capital Advisors, sees crude prices trading mostly in a range between $45 and $55 per barrel for the long term.

Thummel expects uncertainty over Brexit to lead to a greenback rally that, in turn, will put pressure on crude as oil is priced in dollars. Nonetheless, he anticipates that long-term drivers — namely demand from China and India — will support energy prices.

In order to play the sector, Thummel is long several different categories of energy stocks. One is in the infrastructure space, where he is long Sunoco Logistics (SXL) and Enterprise Products Partners (EPD).

“In an environment when the 10-year Treasury [yield] is at 1.5%,” Thummel said, “high-yielding income-producing energy stocks are a great place to invest. Both Sunoco Logistics and Enterprise offer investors really healthy dividend yields — 5% to 7% — plus they grow their dividends every single year and have a track record of doing so. They do that by owning a diverse network of strategic pipeline assets that are absolutely critical to this nation’s energy infrastructure.”

On the production side, Thummel is positive on companies operating out of the Permian Basin in the American Southwest. “Pioneer Natural Resources (PXD) is one of our larger holdings,” he said. “It’s a company that owns a large number of acres in the Permian Basin. It’s growing its production volumes and it’s one of the few oil companies that is growing production volumes in this price environment.”

Outside of petroleum, Thummel is also bullish on natural gas. He is long EQT Corporation (EQT) and Spectra Energy (SE) because of their operations in the Marcellus Shale, a region covering parts of New York, Pennsylvania, West Virginia and Ohio.

“The growth potential for natural gas being produced from the Marcellus Shale will be quite dramatic,” he predicted. “Over the next several years it’s going to fill demand over the long-term basis for not only for the US but for Mexico [and] potentially for Canada.”

[valuentumbrian]

After Bold Call on KMI, Nelson Reiterates Views on MLPs

By The Valuentum Team

How to interpret the mispricing of MLP shares in the image below: In this illustrative example that includes both growth capital spending and a marginal cost of capital of 10%, holders of MLPs will have to wait years before the intrinsic value of the security catches up to the present market price (comparison shown in orange). Said differently, units in this example are significantly overpriced in today’s market. 

President of Valuentum Securities Brian Nelson is reiterating the increasing likelihood of a “bust” scenario that may happen with respect to the master limited partnership universe, outlined several months ago. 

Published in late September as “Warning: The Master Limited Partnership Model May Not Survive” on www.valuentum.com, Barron’s had also highlighted Mr. Nelson’s concerns about the sustainability of the MLP business model in their write-up,  “Why the MLP Business Model May Be a Goner.” For more background on Mr. Nelson’s bold call on Kinder Morgan, please select here.

The risks continue to mount as commodity prices suffer and a contractionary monetary environment draws nigh. The late September article warning about the potential fallout in the MLP universe is provided for everyone’s convenience below:

Warning: The Master Limited Partnership Model May Not Survive, published September 28 by Valuentum’s Brian Nelson, CFA

Warren Buffett has famously said that, “only when the tide goes out do you discover who’s been swimming naked.” We now know what’s been swimming naked, and it’s the master limited partnership (MLP) business model during the latest downdraft of this energy cycle. A tremendous fall-out may still be ahead for MLPs, unfortunately, as energy markets weaken and as credit markets tighten.

We now believe the financial operating structure of the MLP may not survive in its current form, even as we say that most businesses using the MLP model are good ones. Our view continues to be that most master limited partnerships including Energy Transfer Partners and most midstream corporate business models including Kinder Morgan are dependent on external capital market assistance to fully fund the current levels of their distributions and dividends, respectively. Their distributions and dividends are not sustainable via internally-generated, traditional free cash flow generation, as measured by cash flow from operations less all capital spending.

However, most traditional brokerage houses have set the price targets of these entities on the faulty belief that their dividends and distributions are a clear and reliable reflection of their underlying operations, as they are with most other corporates. In light of the external capital market assistance that is necessary to support the payouts, however, such dividends and distributions are not; in our view, they are far from it. The industry’s definition of “distributable cash flow,” which completely ignores the very growth capital that drives future net income, which itself is included in distributable cash flow, further complicates this severe valuation imbalance.

With seemingly infinite support from the external capital markets and investor thirst for income, most master limited partnerships and midstream corporates have been holding on to the belief that their distributions and dividends are invincible, and some may still believe this to be true. After all, they may argue, with unlimited access to incremental external financing via new equity and debt, which entity couldn’t grow its dividend or distribution to the moon? This line of thinking comes with a kicker, too. As long as the brokerage houses price such equities on these “financially-engineered” dividends, the price of their stocks would also be propped up, and in turn, the creditworthiness of the entity, its corporate credit rating, would be healthy, too.

But this self-perpetuating, debt-infused “bubble” is coming to an end, in our view, now that bankers are re-evaluating price decks and borrowing capacity and as the energy markets swoon. Most master limited partnerships and midstream corporates may have to make the difficult decision to either cut their distributions/dividends or suspend growth plans in them altogether, a move that would completely negate forever the dividend-based equity pricing framework used by brokerage houses, leading to a further unraveling of equity prices. Falling stock prices would then weaken credit quality, and a bust would truly ensue, as shares finally revert back to traditional, tried-and-true free cash flow valuation processes, as opposed to one based on a financially-engineered payout.

That the merger between Energy Transfer Equity and Williams, announced September 28, fetched a price far below levels of just a few months ago (now $33 billion was $48 billion) means that the environment continues to deteriorate at a pace faster than even we are observing, and in our view, participants are becoming desperate in the face of adverse conditions. Many MLPs and midstream corporates, for example, may no longer be able to hide behind their 2015 slide decks as investors are now demanding the sensitivity of their operating assumptions to present-day, real-life energy resource pricing levels and their impact on projected performance in 2016 and 2017.

As existing hedges for most midstream entities roll off, either material pressure on cash flow from operations would then ensue once new hedges are put in place at lower prices, or a significant increase in their sensitivity to the spot rate of key commodities would prevail, by a factor that perhaps executive teams may not even know. The very idea that OPEC continues to produce to put the clients of most midstream operations out of business means that MLPs and corporate midstream entities will never be able to truly escape the reality that they, too, are inextricably tied to commodity prices.

Several midstream MLPs have already warned that distribution growth would disappoint including Plains All American, and upstream players including Linn Energy have already ripped the Band-Aid off with an outright suspension. We think the stock market will eventually demand that such entities pay their distributions and dividends out of earnings and traditional free cash flow, like most every other dependable dividend-paying corporate out there, and that means the sledding in their share prices will continue. The corresponding hit to credit health across the sector in the event of further weakness in equity prices then might very well create the unraveling we had outlined several months ago.

The MLP business model, as we know it today, may not make it through the other side of this downdraft of the energy cycle. Storm clouds are gathering.

We hope you have benefited from the unique insights and the predictive, forward-looking nature of the Valuentum process, which considers an in-depth discounted cash flow valuation, relative valuation assessment, and technical/momentum indicators. Our best wishes to all, and we trust you saved as much as half of your capital by heeding Mr. Nelson’s warning.

Mr. Nelson’s body of research on the midstream space and follow up to the rebuttal of this article, also published by Barron’s, can be accessed at www.valuentum.com.

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May everyone have a wonderful holiday season! Don’t forget to give the gift of a Valuentum membership today. Subscribe here. We’re also hosting a workshop detailing our concerns with the MLP universe here. Don’t delay; reserve your spot today.

Pipelines - Oil & Gas: BPL, BWP, DPM, ENB, EPD, ETP, EVEP, HEP, KMI, MMP, NS, PAA, SE, SEP, WES

Want to stay ahead of the market? Consider adding Valuentum’s investment research services to your investment toolkit. Subscribe here.

This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice. For more information about Valuentum and the products and services it offers, please contact us at [email protected].

[valuentumbrian]

Recapping The KMI Call Made By Valuentum’s Nelson

Image published June 18, 2015. (C) Valuentum Securities

The image above was taken from Valuentum’s President Brian Nelson’s article published on www.valuentum.com June 18. If you’re interested in learning more about how to identify mispricings in the stock market such as that with Kinder Morgan when it was trading at $40 per share (now ~$20), please consider becoming a member to www.valuentum.com. You’ll gain access to Brian Nelson and the Valuentum Team. Click here to subscribe today!

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By The Valuentum Team  

Revisiting the 10 Reasons Why Valuentum Thought Kinder Morgan’s Shares Would Collapse, released June 2015 when shares were trading at ~$40 each

1) The valuation paradigm has changed.

2) Kinder Morgan's dividend growth endeavors will disappoint.

3) The company's net debt load is $40+ billion.

4) The company is trading at 40+ forward earnings.

5) The natural reaction from shareholders will be skepticism and disbelief.

6) Kinder Morgan’s dividend is in part organic, in part financially-engineered.

7) The traditional “blind” use of the dividend discount model does not apply to Kinder Morgan.

8) The company’s implied leverage is 19 times after considering all cash, debt-like commitments, at least in the eyes of shareholders.

9) Bondholders will start to care. Equity holders will start to care. They will – and then it all unravels.

10) Highly-publicized insider purchases are not a sign of support, in the case of Kinder Morgan, but an admission of vulnerability.

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On June 11, Valuentum’s President Brian Nelson wrote ‘5 Reasons Why We Think Kinder Morgan’s Shares Will Collapse,” removing the company from Valuentum’s Dividend Growth Newsletter portfolio that day at $40 per share.

The piece was highlighted by Barron’s in ‘The Bear Case Against Kinder Morgan’ later that evening. The controversial call did not go unnoticed. Shares of Kinder Morgan (KMI) and most of the master limited partnership arena fell ~2% on the opening the following day. Credit Suisse’s John Edwards released a rebuttal to Valuentum’s “5 Reasons” piece point by point June 15, reiterating Credit Suisse’s Outperform rating and $52 price target at the time, quipping that his team had agreed that the ‘natural reaction from shareholders would be skepticism and disbelief.’

Valuentum’s President Brian Nelson then countered June 18 with ‘5 More Reasons Why We Think Kinder Morgan’s Shares Will Collapse’ defining how Valuentum’s thesis was separate and distinct from Barron’s and Hedgeye’s February 2014 piece, which focused primarily on the MLP and a questioning of the MLP’s measure of sustaining capital expenditures, something that the company had already refuted. Shares of Kinder Morgan, the corporate, had peaked at nearly $45 per share in April 2015, up from the low-$30s range in February 2014 when the Barron’s piece had been released. Barron’s said Nelson was back as the “Kinder Morgan Bear: 5 More Reasons to Worry,” released June 19.

Unlike the traditional “short case,” which searches for a “fire” within a company’s accounting or some other tragic situation, Nelson’s 10 reasons, published in June 2015, were based purely on a valuation and credit assessment of the corporate, which he felt was severely misaligned in the context of the entity’s fundamentals. The Kinder Morgan MLP units, formerly trading under the symbol KMP, the security which Barron’s and Hedgeye’s February 2014 piece had primarily focused on, had since been retired after the closing of the deal November 2014. KMP unitholders benefited from a 12% premium the day of the deal announcement.

Nelson then publicly released his $29 per share fair value estimate of Kinder Morgan on June 30, “Kinder Morgan’s Fair Value: $29 Per Share, with shares of the third-largest energy company in North America trading in the high $30s.” On Kinder Morgan’s second-quarter conference call July 15, investors continued to confuse Mr. Nelson’s 10 reasons with the previous thesis on the MLP outlined in 2014, with an investment management firm proclaiming that shares were being punished by “the timely or untimely resurrection of what I thought was a wholly discredited bear attack by a tabloid claiming that your investment grade debt is not serviceable.” Mr. Nelson's thesis was genuine and unique.

Valuentum agrees that the “short thesis” published on February 2014 by Barron’s had been “discredited” once Kinder Morgan had rolled up its MLP structure. After all, the security KMP had ceased to exist. Nelson’s thesis had only focused on the Kinder Morgan corporate, the ticker symbol KMI, shares of which were trading at $37.50 in mid-July. Nelson then took the show on the road, presenting his concerns about Kinder Morgan and MLPs, in general, at the AAII chapters in Cleveland, Silicon Valley, Milwaukee, and Madison in the subsequent months, hoping to help investors avoid any further collapse in shares that was to come.

As his concerns grew, Nelson then published, “Warning: The Master Limited Partnership Model May Not Survive” in late September and shared it with Barron’s as a follow up to the Kinder Morgan call, published as “Why the MLP Business Model May Be a Goner.” By September 29, shares of Kinder Morgan, the corporate, had collapsed to ~$26 each. Shares of the Alerian MLP ETF (AMLP) had collapsed from $16.15 per share on June 11 to $11.51 over the same time frame.

Nelson thesis was then validated. On October 22, Kinder Morgan revised lower its dividend growth plans and detailed how it would engage in sophisticated financing needs to stay afloat. Shares of the corporate fell even further. Credit Suisse’s John Edwards downgraded the rating of Kinder Morgan from Outperform to Neutral and reduced the price target to $39 per share, noting “in the 13 years of following KMI, we don’t recall management having to reduce guidance…ever.” That day, Nelson reiterated the low end of his fair value estimate range for shares of ~$23 each.

Argus subsequently cut Kinder Morgan’s price target to $35 per share from $50 per share November 10, still rating the company a “buy.” On December 2, Moody's then downgraded Kinder Morgan's credit rating outlook, an integral part of Mr. Nelson's thesis and what he described as "the circular flow of unsubstantiated support." Kinder Morgan’s shares, the corporate, trading under the symbol KMI, are now exchanging hands in the low-$20s per share, at the low end of Valuentum's fair value range.

We hope you have benefited from the unique insights and the predictive, forward-looking nature of the Valuentum process, which considers an in-depth discounted cash flow valuation, relative valuation assessment, and technical/momentum indicators. Our best wishes to all, and we trust you saved as much as half of your capital by heeding Mr. Nelson’s warning. 

May everyone have a wonderful holiday season! Give the gift of a Valuentum membership today. Subscribe here. We’re also hosting a workshop detailing our concerns with the MLP universe here. Don’t delay; reserve your stop today.

Pipelines - Oil & Gas: BPL, BWP, DPM, ENB, EPD, ETP, EVEP, HEP, KMI, MMP, NS, PAA, SE, SEP, WES

This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice. For more information about Valuentum and the products and services it offers, please contact us at [email protected].

Image Sources: Roy Luck, Simon Cunningham, Images Money, Trading View. No alteration has been performed on the pictures.

[charlessizemore]

3 High-Yield MLPs to Buy Amid the Crude Oil Rout

A few weeks ago, on one particularly rough day for the MLP sector, I wondered to myself who had just blown up. With even blue-chip names down 4% or more on the day, the only explanation I could come up with was that a leveraged MLP hedge fund must have “blown up” and been forced to liquidate its holdings due to margin calls, pushing down prices. Nothing else made sense. 

I never got an answer to that question, and I will probably never know. But when I see the continued meltdown in the MLP space, I’m still left wondering: What, exactly, are investors thinking when they dump MLPs at today’s prices? 

When they can get a 5% current yield or better and distribution growth of 5% to 10% per year for the foreseeable future… where exactly do they expect to find better bargains? 

Hey, I get it. The collapse in the price of crude oil is scary. I wouldn’t particularly want to own an upstream exploration and production MLP like Linn Energy (LINE) in this environment. But most of the larger MLPs get most of their revenues from midstream transportation and are mostly insensitive to energy prices. And whatever modest exposure to energy prices they have right now can’t quite justify the 22% decline in the JPMorgan Alerian MLP ETF (AMJ) since early May. 

Today, I’m going to take a look at three midstream MLPs that have taken an unjustified beating. All pay fantastic dividends or distributions, and all are expected to see significant growth over the next several years.

Enterprise Products Partners

I’ll start with Enterprise Products Partners (EPD), considered by many, including myself, to be the bluest of blue-chip MLPs. Enterprise Products operates 51,000 miles of oil and gas pipelines in additional to extensive salt-dome storage capacity and marine transportation. 

By management estimates, about 85% of Enterprise Products’ income is fee-based, depending on the volume of oil and gas transported rather than the price. And most of EPD’s price sensitivity is due to its natural gas liquids business. 

Enterprise Products is down about 23% since early May on no real news. Distributable cash flow for the first half of the year was roughly flat with the same period from 2014.That might have been modestly disappointing to investors hoping for growth, but it’s hardly devastating news. 

At today’s prices, Enterprise Products yields 5.9%, and that distribution is about as safe as they come. Its distributable cash flow covers its current distribution by 1.3 times, giving Enterprise plenty of room to grow its distribution even if cash flows fail to grow as quickly as in years past.

Kinder Morgan

Up next is  Kinder Morgan (KMI), the only MLP that can compete with Enterprise Products in terms of size and scope. 

Kinder Morgan is not technically an “MLP.” It’s a corporation. But I’m comfortable including Kinder Morgan here because, up until last year, this sprawling pipeline empire actually included three underlying MLPs in addition to the general partner. 

Like Enterprise, Kinder Morgan has gotten slapped around lately, down about 30% since late April. But this is absurd when you actually take the time read Kinder Morgan’s most recent quarterly earnings release. Kinder Morgan increased its project backlog by $3.7 in the second quarter to $22 billion, meaning that KMI has no shortage of growth prospects in front of it. 

During its reorganization last year, management said that it intended to raise KMI’s dividend by at least 10% per year from 2016 to 2020, and they reiterated that call this past quarter. And at today’s prices, the stock yields a whopping 6.4%. 

Between the current dividend and the expected growth rate, you should be looking at minimum annual returns of about 16% per year over the next five years. That’s enough to double your money in a market that is expensive and priced to deliver almost nothing in the way of returns over the next decade.

Teekay Corporation

And finally, I get to one of the quirkier companies in the midstream space, Teekay Corporation (TK). Most MLPs own pipelines; Teekay owns tankers. 

It’s a different vehicle, but it’s the same basic idea. Rather than drill for oil and gas, Teekay simply moves it around. Like Kinder Morgan, Teekay is technically a corporation and not an MLP. But this is where it gets interesting. Teekay is the general partner of two MLPs, Teekay Offshore Partners (TOO) and Teekay LNG Partners (TGP) and the controlling shareholder of another corporation, Teekay Tankers (TNK). 

Rather than continue as an operating entity in its own right, Teekay Corporation is transitioning into a pure-play general partner by dropping its operating assets down into its MLPs. And that can only mean one thing: A big surge in dividend growth. As part of Teekay’s strategic shift, it boosted its dividend by 70% earlier this year, and management expects annual dividend growth of 15% to 20% over the next three years. 

Between that stellar growth rate and Teekay’s current 7% dividend, you’re looking at doubling your money in about three years.

Disclosures: Long EPD, KMI, TK

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. 

[charlessizemore]

10 Market Predictions for the Rest of 2015

So far, 2015 has proven to be an unusual year. The stock market has gone virtually nowhere in 12 months, bonds yields are actually well off their highs for the year despite a looming rate hike from the Federal Reserve, and crude oil prices have fallen at a pace last seen during the 2008 meltdown. The market will continue to keep us all guessing. That’s what markets do best. 

But I’m going to hazard 10 predictions for the remainder of 2015 covering everything from crude oil prices to the Spanish unemployment rate and everything in between. 

Some of these are contrarian calls well outside of the mainstream. But as 2015 has trained us to expect the unexpected, I believe them to be the right calls. 

So with no more ado, let’s jump into it.

#1. The Fed Raises Rates Once … and Then Stops

This has been the most telegraphed Fed tightening in history. In fact, you could argue it started over two years ago, in May of 2013, when Ben Bernanke, then the Fed Chair, first started making noise about tapering his quantitative easing program. And once quantitative easing was tapered out of existence, it was only a matter of time before the focus shifted to “liftoff” from the zero-interest-rate policy (“ZIRP”) that has been in place since the dark days of the financial crisis. 

Fed Chair Janet Yellen, has been talking the good talk about raising the Fed Funds rate for most of 2015, so none of us can act surprised when she finally does it either next month or in December. 

But here’s the thing. She waited too long. It has been more than six years since the last recession. In the entire span of U.S. history since the Great Depression, the longest stretch we’ve ever gone without a recession was 10 years — and that was during the 1990s tech boom. Since the Great Depression, the average time between recessions was four years and nine months. 

So while this doesn’t mean a recession is necessarily around the corner, we’re certainly due for a slowdown, and a lot of the economic data of the past few months has been tepid at best. GDP growth is sluggish, and inflation is dead on arrival. None of this is a recipe for aggressive Fed rate hiking. 

The Fed really wants to raise rates. They want to give themselves room to lower rates next time we have a recession. But they don’t want to cause a recession in the process, so I expect a rate hike of no more than 0.25% to 0.50%, making this the shortest tightening cycle in history.

#2. Bond Yields Finish the Year Lower

This is a contrarian view, to say the least. “Everyone” expects bond yields to rise through the remainder of this year and beyond. But falling yields are consistent with my view that the U.S. economy is due for a cooling. Our current economic expansion, which has been aided by the most aggressive central bank action in history, is looking long in the tooth. Yet it never quite gathered enough speed to give us strong growth or to ignite the inflation the Fed was hoping to see. 

Inflation is the single biggest worry for the bond market. Rising inflation means rising bond yields … and falling bond prices. Well, the most recent 12-month consumer price inflation figures showed inflation of just 0.1%. Excluding food and energy, it was a more respectable 1.8%. But that’s still below the Fed’s target of 2.0%. 

Until we see a sustained uptick in inflation, we’re not likely to see bond yields go much higher. But there are other factors at play, too. With the aging of the Baby Boomers, the hunt for yield, which has been a theme now for over a decade, is only going to intensify. And lower yields in Europe and Japan will put an anchor of sorts on U.S. bond yields. 

And finally, there is precedent. Following its spectacular bubble and bust in the early 1990s, Japanese bond yields continued to drift lower … for 20 years and counting. So anyone who tells you that bond yields “can’t go lower” or “can’t stay this low for long” clearly has never bothered to read a history book.

#3. The REIT Rally Gathers Steam

Real estate investment trusts  have come to be viewed as bond substitutes over the last decade. REITs are excluded from paying federal income tax so long as they distribute 90% of their profits as dividends. That fact makes REITs excellent long-term income vehicles … though it also makes them very sensitive to interest rate moves. 

Because REITs dish out virtually all of their income as dividends, they keep very little on hand to make new acquisitions. This means that REITs are always having to go to the capital markets for new debt and equity. Rising market rates mean rising borrowing costs … which crimp REIT profits.Real estate investment trusts (usually referred to as REITs) have come to be viewed as bond substitutes over the last decade. REITs are excluded from paying federal income tax so long as they distribute 90% of their profits as dividends. That fact makes REITs excellent long-term income vehicles … though it also makes them very sensitive to interest rate moves. 

But it’s also much simpler than that. In a world with 2% bond yields, a 3% REIT looks like a steal by comparison. But if the bond yield rises to 3%, a REIT investor needs to see a yield of, say, 4% or higher to make the investment worth their while. So, rising bond yields make REITs less attractive. 

REITs have spent most of 2015 in freefall as investors are pricing in the worst. Some REITs are down more than 20% in 2015, due almost exclusively to fears of rising bond yields. 

If I’m right about bond yields falling rather than rising, then REITs are an absolute steal at today’s prices. And in fact, REITs have spent most of the past six weeks quietly rallying. Between now and the end of 2015, I expect REIT investors to see very nice returns between the high dividends and the potential for capital gains.

#4. Predictions: Oil Finds a Bottom

This year has been absolutely brutal for anyone with a position in crude oil. Over the past 12 months, the price of crude oil has been more than cut in half. It’s a perfect storm: Massive new supply coming out of the United States and Canada at a time when demand is waning from a slowing China and years of energy efficiency gains. 

The market is practically sloshing with excess crude oil. It’s bad out there in the oil patch, to say the least. 

But here’s the thing. Supply gluts don’t last forever, and markets tend to overreact to recent information. I don’t know at what price crude oil will eventually find its bottom. West Texas Intermediate might bottom out today, in the low $40s. Or it may very well drop another $20. Only time will tell. But low prices push less competitive producers out of business and spur new demand. Already, Americans have responded to lower oil prices by buying bigger trucks and SUVs. 

I can’t tell you the exact date and price at which crude oil will find a bottom. But I expect it will be a lot sooner than most people seem to think, and I’m betting it finds that bottom between now and the end of 2015.

#5. Midstream MLPs Finish the Year Strong

Because of plunging crude oil prices, virtually everything even tangentially related to oil has gotten clobbered, including midstream pipeline MLPs. 

Midstream MLPs are unaffected by energy prices, as their revenues are determined by the volume of oil and gas passing through their pipelines and not their prices. 

Well, that’s the theory, anyway. The reality is a little more complicated. Most of the larger MLPs have multiple business lines, some of which do indeed have sensitivity to energy prices. And in some cases, the contracted pricing that midstream MLPs receive is directly tied to the price. 

But here’s the thing. These are the exceptions and not the rule. The larger midstream MLPs that investors are likely to own, such as Enterprise Products Partners (EPD) or Kinder Morgan (KMI), get the vast majority of their earnings from operations that are not affected by energy prices. 

Sure, the weakness in their other business lines might slightly reduce distribution growth over the coming years. But if so, it would only be by a modest amount. Most of the large midstream MLPs have claimed in their earnings announcements that their distributions are safe for the foreseeable future, and most still expect healthy distribution growth over the next several years. 

Once this wave of panic selling passes, expect MLPs to enjoy a massive rally throughout the remainder of 2015. Prices and yields this attractive don’t stay available forever.  

#6. Apple Gets Its Mojo Back

Apple (AAPL) has long been the company that could do no wrong. It had a talent for creating demand for products that had never existed until Apple invented them. From the launch of the original iPod until today, Apple has been one of the greatest growth stories in the history of capitalism. 

Alas, in the world of investing, the question always becomes “What have you done for me lately?” And right now, Apple is a victim of its own success. 

Sales of the iPhone 6 and 6 Plus absolutely crushed all expectations, giving Apple a massive windfall in the first half of this year. But the Apple Watch hasn’t quite lived up to the hype, there are fears that a China slowdown with crimp growth, and the market seems to be realizing what should have been obvious from the beginning: The torrid pace of iPhone 6 sales isn’t sustainable. There was a massive one-off upgrade rush from Apple fans that had been craving a larger screen. 

And guess what. At today’s prices, none of this matters. Despite being the largest company in the world by market cap, Apple is one of the cheapest large companies in the world. It trades at a forward P/E of just 12. Stripping out Apple’s gargantuan cash hoard, you get down to a single-digit P/E valuation … for Apple, the most profitable company in the world. 

As I wrote recently, Apple has enough cash in the bank to sustain its dividend at current levels for more than a decade … without earning a single dime in additional profit. I agree with Carl Icahn. Apple is worth at least $240 per share , more than double today’s price.

#7. European Stocks Blow American Stocks Out of the Water

I’ve made no secret of my preference for European stocks at today’s prices. While U.S. stocks are priced to deliver flattish returns over the next several years, many European markets are priced to deliver healthy returns of 7% or more. 

After the worst of the crisis had passed by early 2009, it’s been mostly smooth sailing for the U.S. markets. Stocks long ago surpassed their pre-crisis highs.I’ve made no secret of my preference for European stocks at today’s prices. While U.S. stocks are priced to deliver flattish returns over the next several years, many European markets are priced to deliver healthy returns of 7% or more. 

But Europe has had a very different experience. Shortly after the 2008-2009 crisis had passed, Europe had a secondary sovereign debt crisis. As Greece, Ireland, Portugal and even Italy and Spain looked headed for possible default or an exit from the Eurozone, the survival of the European project seemed at risk. Most European markets continued to suffer in bear market conditions long after the U.S. had entered one of its greatest bull markets in history. 

Only today, three years after ECB President Mario Draghi promised to do “whatever it takes” to save the eurozone, have investors come to view Europe as a viable investment destination again. With European markets very attractively priced, at least in relation to the U.S. market, I expect European markets to outperform for the remainder of 2015.

#8. Spain’s Unemployment Rate Finally Dips Below 20%

I have fantastic news. Spain’s unemployment rate dropped to “only” 22.4% last quarter, down from 23.8% in the first quarter. It was as high as 26.9% in 2013. 

Those numbers are hard for an American to wrap their mind around. The last time we had unemployment rates anywhere close to that high was during the Great Depression. 

But here’s the thing: Spain always has high unemployment. Even during economic booms. It’s average unemployment rate since 1976 has been 16.4%. Even during the go-go years of the mid-2000s, one of the greatest growth booms in Spanish history, the unemployment rate barely cracked below 8% — a level that would be considered a crisis here in the United States. 

The situation in Spain is never quite as bad as it looks. A lot of the “unemployed” are actually employed in service sector or in the informal economy but get counted as “unemployed” due to quirks in the way Spain tallies the data. 

In any event, Spain is quietly growing and is expected to see GDP growth of 3.3% in 2015. That should help to bring Spanish unemployment a little closer to its historic averages.

#9. Chinese Stocks Drift Lower

It’s hard to have a proper bear market when you’re not legally allowed to sell your shares. But that is the situation in China today. In trying to avert a stock market collapse, the Chinese authorities have put major restrictions on short selling. Earlier this summer, the regulators halted trading by large shareholders for six months. At one point, so many restrictions were in place that only 3% of Chinese stocks were actually able to trade. 

Perhaps not surprisingly, the bear market conditions have abated slightly. Stock prices can’t really fall when you’re not allowed to sell them. 

But the bear market in Chinese stocks is far from over because confidence has been completely undermined. No one in their right mind would buy a stock they would then be unable to sell. So, bottom line, don’t expect the bull market in Chinese stocks to resume any time in 2015. Investors burned by the selloff aren’t likely to come back for more anytime soon.

#10. Russia Comes in From the Cold and Embraces the West

OK, this last one was a joke. The Russian bear has most assuredly not grown cuddlier in recent months, and I don’t see this happening any time in 2015. In fact, in early August, Russia ratcheted it up a notch. On the anniversary of the Western sanctions that were put into place after the annexation of Crimea,

Russia made a very public statement by bulldozing a massive pile of European cheese. And it didn’t stop with a War on Cheese. Polish apples and tomatoes were next to feel the wrath of Russian president Vladimir Putin. So far, 28 metric tons of Polish apples and tomatoes have been destroyed. 

I’m assuming that Mr. Putin has a shred of decency and won’t allow for the wanton destruction of perfectly good German beer or Spanish ham. But sadly, there are casualties in all wars. 

It was low energy prices that contributed to the eventual fall of the Soviet Union, and it may well be low energy prices that take down Putin’s nationalist regime. But I most certainly don’t see that happening in 2015.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. 

Photo credit: Angela Mabray

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Kinder Morgan is On Sale Again With a 6% Dividend

It’s been an absolute bloodletting in the midstream oil and gas MLP space. As the bear market in oil prices has taken another leg down, everything even tangentially related to energy has gotten crushed. Even the blue chips with minimal exposure to prices have been left for dead.

Kinder Morgan (KMI) and Enterprise Products Partners (EPD) are down 23% and 28%, respectively, since late April. Seaborne midstream MLP general partner Teekay Corp (TK) is down by about a third. Whenever I see destruction like that, it gets my attention. A stock is not always a bargain because it has fallen in value. Sometimes a cheap stock is cheap for a reason. 

But as often as not, the market really does overreact and presents us with a good buying opportunity. Let’s take a look at Kinder Morgan and see if we have one of those opportunities today. 

The selloff in Kinder Morgan and other MLPs this summer has been peculiar because KMI stock mostly avoided the pain that hit the rest of the energy sector a year ago when the price of crude oil first began falling. The massive declines are happening now, months after the oil supply glut should have been old news. Some of this is due to belated fears that U.S. domestic production – which has been slowing in recent weeks – will crimp the volume growth that drives pipeline profits. That’s a legitimate concern. But hardly one that would justify this kind of move in the stock price, particularly when you consider Kinder Morgan’s most recent quarterly earnings release. 

Kinder Morgan increased its project backlog by $3.7 in the second quarter to $22.0 billion, meaning that KMI has no shortage of growth prospects in front of it. Lower energy prices are a problem, to be sure. While KMI gets the vast majority of its revenues from fee-based contracts that are not sensitive to energy prices, the company is not completely immune. KMI estimates that every $1 change in the price of crude oil lowers distributable cash flow by $10 million. That sounds like a lot of money, but remember that Kinder Morgan produces over $15 billion per year in sales. Even at today’s depressed priced, KMI generated enough distributable cash flow in the first half of the year to cover its dividend with $226 million to spare. 

And speaking of that dividend…last month Kinder Morgan raised its dividend by 14%, and management reaffirmed that it intended to raise KMI’s dividend by at least 10% per year from 2016 to 2020. 

At today’s prices, KMI’s $1.96 per share dividend works out to a yield of 6.1%. If KMI is able to follow through on its promise of 10% annual dividend growth, by 2020 its annual dividend will be a cool $3.16. That works out to a yield on today’s price of 9.8%. 

Between the current dividend and the expected growth rate, you should be looking at minimum annual returns of about 16% per year over the next five years. That’s enough to double your money. 

And don’t take my word for it. Watch what the company insiders are doing. 

Richard Kinder, the founder and chairman of Kinder Morgan, bought over $11 million in KMI stock in June and July. And since December of 2013, Mr. Kinder has spent $56 million of his own money buying shares. And he’s not the only one. Board member Fayez Sarofim dropped $17 million last month buying shares, and since December of 2013 various Kinder Morgan insiders have plowed nearly $90 million into company stock. 

It’s worth noting that Richard Kinder takes no salary for his work as chairman. His only compensation is via the dividend on his vast holdings of KMI stock. So it’s in his best interests – as well as ours – to keep the dividend checks growing. After the recent rout, KMI stock is a steal. Use this lull as a buying opportunity. 

Disclosures: Long KMI, EPD, TK

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. 

Photo credit: Thomas and Dianne Jones