Inside the MLP Factory
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Transcript of Inside the MLP Factory
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Inside the MLP Factory
Igor GreenwaldThe Wealth Summit
May 2014
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Do You Like Sausage?
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I know I do; let me count the ways:
• Grilled, with onions
• Smoked with sauerkraut • On a stick, fried in pancake batter (Not really, but someone out there does.)
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What does sausage have to do with master limited partnerships?
Only this:
The end result is much more appealing than the preparation process
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Why the bad rap for sausage factories?
“If you like laws and sausages,You should never watcheither one being made.” ─ Otto von Bismarck, maybe
Another thing The Iron Chancellorprobably didn’t say:
“If you like pithy quotes, don’tworry too much about attribution.”
Blame this man:
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How are MLPs like laws and sausages?
Complex process
Assembled by specialists
Defects hard to spot
Fill a need for the public
Producers can profit by fooling consumers
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The insinuation: If only you knew“The $500 billion master-limited-partnershipsector is the sausage maker of the investmentworld. Buyers love the yields ─ now averagingabout 6% ─ but many know little about how theyields are generated. And Kinder Morgan, thecountry's largest energy-infrastructure company,may be the biggest sausage maker of them all.”
“Kinder Morgan: Trouble in the Pipelines?”
Barron’s, Feb. 22, 2014
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And yet, here’s what we know:
• Sausage is tasty
• Laws keep anarchy at bay
• MLPs have been the best investment so far in this century
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Deal of the Century
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Source: Pension Consulting Alliance
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Source: Pension Consulting Alliance
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Source: Pension Consulting Alliance
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Source: Pension Consulting Alliance
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How Fresh Is That Sausage?
• Past performance does not predict future
• Outperformance won’t last forever
• Risk of reversion rises over time
• The role of sentiment in market cycles
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Reality Check
Source: William Blair
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The People’s Choice Predictable tax-deferred income
Exempt from corporate income tax
Long-term contracts, regulated tariffs
Yield above bonds, REITs, utilities
Growth industry amid US shale boom
Great long-term track record
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No Contest
Source: Alerian
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Drill, Baby, Drill
Source: US Energy Information Administration
Projected US energy production
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Moveable Feast
Source: RBN Energy
Government shale forecasts keep missing low
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Good Times, Not So Bad Times
Five Best Years
2009: 76%
2000: 46%
2003: 45%
2001: 44%
2010: 36%
Selected Alerian MLP Index annual returns since 1996
Five Worst Years
2008: -37%
1999: -8%
2002: -3%
1998: -3%
2012: 5% Sources: Alerian, Hinds Howard
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The Price of Success
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MLP Bulls Come LatelyNew investment vehicles by year of launch
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Drilling for Cheap Capital
Source: Hinds Howard
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C-Corps ♥ Selling MLPs
Recent Spinoffs: Phillips 66 Partners (PSXP) from Phillips 66 (PSX) – top ‘13 MLP IPO Valero Energy Partners (VLP) from Valero Energy (VLO) Western Refining Logistics (WNRL) from Western Refining (WNR) EnLink Midstream Partners (ENLK) from Devon (DVN) and Crosstex (XTXI) Enable Midstream (ENBL) from CenterPoint (CNP) and OGE Energy (OGE)
More In Store: Dominion Midstream LNG MLP from Dominion (D) Antero Resources Midstream MLP from Antero Resources (AR) LNG tanker MLP from GasLog (GLOG) Offshore drilling rig MLP from Transocean (RIG) LNG processing MLP from Energy Transfer Equity (ETE)
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Devon’s Sweet Deal
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• Devon valued (still!) at less than 5x EV/EBITDA
• Deal valued auxiliary midstream assets at 11x EBITDA
• Devon’s contribution to MLP valued at $4.8 billion
• Market has since repriced to more than $7 billion, or 16x
EBITDA
• MLP trading at three times Devon’s cash flow multiple
MLP Alchemy
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PSX vs. PSXP
PSXEV = $49.3BEBITDA = $3.4BEV/EBITDA = 14.5
The high cost of the extra “P”
PSXPEV = $3.5BEBITDA = $67.7MEV/EBITDA = 51.7
• PSX owns 72% of PSXP LP units plus 2% GP interest• Investors paying more than triple for PSXP over PSX• Fast distribution growth is nice, but at 1.6% yield, not fast enough• PSXP up 93% in 9 months since IPO, 48% year-to-date• Troubling faith in perpetual growth
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A Different Yardstick
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Bonds Have More Fun
• Fixed income in fourth decade of bull market
• Government bonds don’t have business risk
• On plus side, bond coupons don’t grow like MLP payouts
• If rates rise, MLP yields could follow via capital losses
Why comparisons with credit yields may prove misleading
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What’s Wrong
With This Picture? Anchoring bias assumes starting
price is the right one
No guarantee distribution growth builds partnership value
No guarantee yield is justified by business prospects
Many MLPs are beyond reproach and have very bright prospects, but the exceptions to this rule can be very costly
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The MLP Profits Philosophy
We recommend investments, not tax shelters
We do so based on long-term fundamentals, not yield
We’re bullish on many strong MLPs and GPs
But we’re also not afraid to sell and criticize
Or to admit mistakes and change course
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Strong Performance Record• Last year’s picks returned nearly 40% annualized by year-end
• Portfolio comfortably beat MLP benchmark as well as S&P 500
Timely buys:Energy Transfer Equity (ETE) +66% since 6/7/13EQT Midstream Partners (EQM) +64% since 8/12/13Sunoco Logistics Partners (SXL) +42% since 8/12/13Targa Resources (TRGP) +35% since 11/15/13
Timely sells:Eagle Rock Partners (EROC) -49% since 5/29/13Boardwalk Pipeline Partners (BWP) -42% since 11/15/13
Timely re-buys:Boardwalk Pipeline Partners (BWP) +15% since 4/4/14
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Key MLP Profits Growth Themes
• LPG Exports (EPD, TRGP, NGLS)
• LNG Exports (ETE, WMB, KMI, TGP)
• Oil, Fuels Surge (MMP, SXL, BPL, OILT)
• Northeast Energy (EQM, WMB, MWE)
• GPs With IDRs (ETE, KMI, WMB, AHGP)
• Propane Logistics (APU, NGL)
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A Margin Of Safety
Top 3 Best Buys (EPD, MMP, SXL) averaged excess coverage of more than 50% of distributions at end of 2013
Excess coverage can fund capital projects in place of equity/debt issuance, aiding returns
Top 3 up 16% YTD, 38% in year before yield
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Let’s Talk IncentivesIncentive Distribution Rights (IDRs) pay general partner (GP) growing percentage of MLP cash flow
Typical: 15% of payout above X, 25% above Y, 50% above Z, per unit
Stated rationale: incents GP to grow MLP
Unmentioned: dilutes rewards of growth for limited partners
Perverse: Top hedge funders charge 2/20 fees; many GPs 2/50
Means GP can profit even from losing investment; fund with debt then collect almost 50% of notional cash flow boost. A sweet deal.
Or fund with equity and collect extra IDRs on new units long before any return. Also why some GPs turn their MLPs into serial acquirers
IDRs can have huge effect on returns and are main reason we tend to favor GPs over affiliated MLPs
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Follow the Bouncing IDRs
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In Summary
MLPs in sweet spot of domestic energy boom
Lofty valuations suggest increased risk
Downside from higher rates, lower energy prices
Returns can be tasty, but insiders eat first
We watch sausage get made so you can enjoy
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Thank You.