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MLP's: Weathering The Exit

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If you are an MLP investor, or considering to be one, you are likely trying to determine whether the structure is at yet another crossroad or is on the path towards imminent C-Corp transition.  The next 3 to 12 months will begin to reveal the impact of the FERC ruling and the exodus of capital from MLP funds this past month, which will determine whether MLP's can return to the status of an advantaged structure for raising equity capital.  What is clear at the moment is sentiment  has reached a new low the last few weeks, as the recent search traffic chart below from ETFdb.com suggests MLP's were as concerning to ETF investors as the plight of Facebook and Amazon.  Or perhaps that MLP investors are more concerned than the typical passive investor, either way, investors in search of the MLP truth will find a fairly complex set of factors to digest.  



Google Search



Fund outflows are the result of these concerns and complexities, which drained nearly $1B of capital from MLP fund since mid February s as investors responded to ominous Tax and FERC headlines, wiping out $10B of AUM .  The selling abated this past week as ETF flows turned  marginally positive.  



Fund Flows



The predicament, and challenge, to MLP's can be explained through the historical performance table below of Enterprise Product Partners.  For the past two years, EPD has been raising their annual distributions nearly 5%, while DCF coverage has been trending lower, only to realize the same relatively high cost of capital when distributions were 12% lower.  Management realized the market was not providing any premium for their growth rate, and decided to reduce growth to 2.5%, with improving coverage to reduce the need for external equity capital.  At the moment, there has been no benefit to their cost of capital, which at 7% is much higher than PE's cost of capital, a problem for MLPs when competing new projects.  Enterprise Products has no Incentive Distribution Rights nor much exposure to the FERC ruling, but it is struggling to gain the attention of investors despite their high yield, which spiked to the same level previously when crude traded below $27.   Regardless of the structure, MLP or C-Corp, the market will assign value on the strength of the assets and balance sheet.  Targa Resources and Kinder Morgan both converted to C-Corp on Nov 2015 and August 2014 respectively, and both have generated sub par returns (TRGP +11% and KMI  - 58%), in spite of the broader universe of investors and less emphasis on dividend growth. 






If Funds cannot be expected to attract incremental capital, or at least hold, their Assets Under Management, the demand will need to increase from HNWI and retail investors, who over the last 4 years have seen the midstream story of 2013 disintegrate, and management teams respond with unanticipated actions.   If such an imbalance were to persist, many MLP management teams would hope that a C-Corp structure would offer greater potential for lower capital costs along with a more marketable base of investors, a conclusion reached last week by Tallgrass Energy Partners.



Large Cap Performance



It appears this week that MLP's have found a floor, or equilibrium, which will refocus attention on Q1 results commencing in two weeks.  If an MLP is able to show higher organic volumes translate into higher organic cash flows, investors will realize that the market has mispriced the risk, and units will be an attractive income vehicle relative to some otherwise poor alternatives.  


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