3 Signs It May be Time to Take Profits in This Red-Hot Sector

In the investment business, we’re very good at talking about when to buy. We can wax poetic about the single-digit piece-to-earnings (P/E) ratio and the deep-discount to book value or the return on equity. It’s the selling part we all need to work on…

The reasons investors hang on to a stock are so vast and complex, it would take a team of psychiatrists at least a decade to begin analyzing them. Typically, the two major reasons are greed and emotional attachment. Greed is simple: we like making money and we want to make more. The emotional attachment is the weird part. I’ve always been a big fan of the Warren Buffett philosophy on how to deal with the emotions involved in holding stocks: that stock doesn’t know that you own it. The hundred shares of Cisco (Nasdaq: CSCO) doesn’t tell you it loves you when you come home from work. If it does, we’ve got bigger problems.

It’s OK to sell stuff. Look at it like you would a party. Eventually you have to leave and if you’re an upstanding citizen (as most Street Authority readers are), you prefer to leave when things are nice.

The party with energy master limited partnerships (MLPs) has been quite nice. But it might be time to thank the hostess, grab your wife’s coat and chat about how lovely it was on the drive home.

There are tons of reasons why you should lighten up on energy MLPs. Unfortunately, I’m constricted on time and space so I’ll highlight three of them.

1. Gains are getting obnoxious and slowing down — Many MLP gains during the past two years have been twice that of the broader market.

The Alerian MLP Index has returned 31% during the past 12 months. Atlas Pipeline Holdings LP (NYSE: AHD) has racked up a 268.4% gain during the same period. Kinder Morgan Energy LP’s (NYSE: KMP) trailing P/E has ballooned to 52.5 (not that P/E’s are the primary metric used to analyze energy MLPs, but it’s still a toppy indicator).

I’ll pick on Kinder Morgan a little more for the sake of example. In the past 12 months, the stock has returned 8.4% compared to about 55% for the S&P 500. Now, 8.4% isn’t bad, but it’s nothing like Kinder Morgan’s run for the prior 12 month period of 41.5%. It looks like we’re seeing a little bit of a trend reversal.

2. Public demand and interest is bordering on obsessive — Financial media can’t talk enough about pipeline MLPs. Energy exposure AND yield!

Last week, the ringmaster of the financial media circus, Jim Cramer, interviewed two pipeline company CEO’s on his “Mad Money” TV show, and it seems that every other caller on the show’s “Am I Diversified?” segment holds at least one energy MLP. Obviously, individual investors can’t get enough. The MLPs have had no problem raising capital.

Navios Maritime Partners LP (NYSE: NMM), for example, has announced plans to offer 4 million common units with a 30-day option for the underwriters to purchase an additional 600 thousand units to cover other allotments. And the Wall Street investment-packaging factory continues to crank out products bundling energy MLPs. If the public wants it, Wall Street will manufacture it. Remember all of the tech stock-centric UIT’s (Unit Investment Trusts) and mutual funds of the late 1990s? A lot of us would like to forget…
3. Oil prices are going to trend lower — What goes up is eventually going to come down. Analysts expect West Texas Intermediate Crude (WTI) to trade at $88/bbl, $92.65/bbl and $92.29/bbl on average for 2011, 2012, and 2013. That’s about a 20% pullback based on recent prices.

Yes, analysts are often dead wrong. Yes, there’s plenty of weirdness to go around in the world’s oil spigot also known as the Middle East. But prices will come back. Consumers will tire of $3.50-plus/gallon gasoline and take necessary measures (driving less, carpooling, public transportation, bicycles, etc.) to put the kibosh on demand. Economics 101 — gonna happen.

I’ve always found it interesting how MLP unit prices were affected by oil prices. The MLP’s are basically in the transportation business — much like the railroad. The price of the fluid should be irrelevant to moving it from Tulsa to Tacoma. Markets are queer things aren’t they?

Action to Take –>
The obvious action here would be to take some money off of the table or, at the very least tighten your stop loss orders. No stop loss order? Then by all means put them in place. Another precaution would be to write call options on existing positions. At this writing, a Kinder Morgan September call at $75 pays $1.40 per contract. Can your stock be called out at $75? You bet. But you still kept the income and the option premium. Better safe than sorry.

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