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Wednesday, August 13, 2014 - 14:30
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Wednesday, August 13, 2014 - 14:30

Consolidation in High-Yield MLP Sector Could Boost This Fund 15%

Thursday, August 14, 2014 7:30 AM

There are big changes afoot in the high-yielding energy master-limited partnership (MLP) space.

On Monday, we got news of the biggest energy sector merger since the mega Exxon Mobil (NYSE: XOM) deal that took place last century. This week's deal is a bit more complex than we've seen in the past, but I suspect it also will be much more of a game changer for income investors and traders than any deal in recent memory.

Energy giant Kinder Morgan (NYSE: KMI) announced it will wholly acquire its two MLP structured interests -- Kinder Morgan Energy Partners LP (NYSE: KMP) and El Paso Pipeline Partners LP (NYSE: EPB). The company also will acquire the non-MLP structured Kinder Morgan Management (NYSE: KMR).

This deal means the surrender of its MLP status, which ironically, is an asset class the energy partnership helped put on the investment map. Kinder was one of the first MLPs to become widely owned back in the 1990s.

The company, and the MLP pass-through structure, gradually became a big hit with income investors who were rewarded with yields north of 6%. For example, the current yield on the Kinder Morgan Energy LP is 6%, while El Paso Pipeline yields 6.5%.

The Kinder Morgan deal was met with big approval from Wall Street, as KMP shares spiked 17% on Monday and EPB vaulted 21%. Non-MLP KMR jumped 24% in Monday trade, while KMI was up 9%.

The $44 billion consolidation plan alleviates concerns many on Wall Street had about Kinder Morgan's ability to keep increasing revenue and distributions going forward.

Other MLP operators face similar pressures, and that is likely to lead to more deals of this sort. More consolidation in the space will mean a smaller supply of quality MLPs for income investors to choose from.

Econ 101 tells us that less supply coupled with strong demand causes prices to increase. It is this basic premise that I suspect will drive up the value of MLPs over the next several months, and taking advantage of this law of economics is something traders can do with the ALPS Alerian MLP ETF (NYSE: AMLP).

This ETF holds a basket of the biggest and best MLPs on the market today, including KMP and EPB. The total number of holdings in AMLP is 25, with KMP representing the fund's largest position at 11% and EPB comprising 3%.

As you might expect, AMLP shares spiked in Monday trade, jumping nearly 3% as two of its components soared due to the Kinder deal.

After falling from its all-time high, made in mid-July, AMLP is now flirting with is 50-day moving average again as it nears those highs.

If the universe of MLPs contracts due to more consolidation, then I think we'll see AMLP continue to power higher -- both from spikes in component share prices and from investor buying in remaining MLP structures.

After all, investors still need income. And with the Federal Reserve not set to raise interest rates anytime soon, and with bond yields near record lows, income seekers will continue to flock to high-yield securities such as MLPs.

Recommended Trade Setup:

-- Buy AMLP at the market price
-- Set stop-loss at $17.38, the current 200-day moving average
-- Set initial price target at $21.35 for a potential 15% gain by year's end

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Jim Woods does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of KMP in one or more of its “real money” portfolios.