MLPs: A Great Opportunity In The Near Future, Just Not Yet
- Shares of various MLPs have been battered over the last year.
- It’s a classic case of the baby being thrown out with the bathwater. Attractive MLPs with strong balance sheets have been sold indiscriminately along with over-leveraged operators.
- Soon investors with dry powder will be able to pick up excellent MLP assets for pennies on the dollar.
Crude continues its relentless march downward, blowing through predicted bottoms and calls for reversals. Its fall has surprised many and devastated a few. For us, this has been completely expected. We've been calling for $20 oil since 2014. We know this downward trend won't be over until there's blood in the energy streets… total capitulation... which is why we have our target for oil at $16/bbl.
All is not doom and gloom though. For the investor who is patient, there will be some amazing opportunities available in the oil and gas space in the coming months.
One of the areas we're most intrigued by, besides buying outright crude futures, is the master limited partnerships (MLPs) segment. These companies operate mid-stream energy assets such as storage and pipelines.
MLPs have been killed over the last year. Many have sold off more than the exploration and production (E&P) companies that have direct exposure to the price of oil. On the surface this seems completely illogical. MLPs transport and store oil. They're essentially toll-road operators in the energy space that collect a fee regardless of the price of energy. But in reality, lower oil prices affect them indirectly. When crude prices are low, there is less oil being transported and stored, so they collect fewer fees.
However, we believe the drop in revenues don't tell the whole story why many MLPs have sold off 50-80% over the last 12 months. Instead, we think it has a lot more to do with liquidity. Many closed-end funds invested in MLPs have been forced to sell their holdings due to margin level restrictions. Every sell-off in the MLP market begets another bout of forced selling by the funds that hold their shares… creating a liquidity issue. Investors want to get out of anything that deals in Texas tea - which is understandable if they've continuously been on the wrong side of this trade over the last 18 months.
Remember Buffett's advice, "Be fearful when others are greedy and greedy when others are fearful." It's getting close to that time when it's going to pay to be greedy. Investors with dry powder will be able to pick up excellent MLP assets for pennies on the dollar.
Some names we're looking at are Enterprise Products Partners (EPD) and Magellan Midstream Partners (MMP). Both have strong balance sheets, positive earnings, and solid dividends that face little chance of being cut. Also, directors at both companies have been scooping up shares, with one director at EPD buying over $100 million worth of stock just this last month. This is a strong sign of confidence for those investors thinking about buying in.
There will be immense value in the energy sector in the coming months. You need to be patient and wait for the final washout in oil and a bottom to form. MLPs that are a great bargain today will be an even better buy then. And investors who are standing by with free capital have the opportunity to make a killing over the coming years.
