A Rare Chance For 7%-Plus Yields And Massive Upside
With all of the recent stock market gyrations associated with events in Greece and China, investors may have failed to notice what is happening in the bond market. The rate on the 10-year U.S. Treasury has fallen nearly 10% to 2.2% since mid-July, taking corporate bond yields down as well.
The yield in one sector has actually increased though and has rarely been higher. Besides the higher yield, values have come down and historical data suggest solid returns over the next year.
Earn A 7% Yield And 40% Potential Upside
Strong long-term demand for pipeline transportation and energy storage has not been enough to save midstream master limited partnerships (MLPs) from their energy-related selloff. Energy may have fallen out of favor lately, but it’s important to remember that the U.S. energy production renaissance is a multi-decade theme. While oil and gas production may ebb and flow, the demand for pipeline transportation will remain extremely strong.
A clear sign of industry demand: Roughly 850,000 barrels of oil are transported daily on our nation’s rails, despite relatively higher costs for that mode of transport. The knee-jerk reaction to lower energy prices has led to steep cuts in capital spending and should aid pipeline supply/demand dynamics for a while to come.
The Alerian MLP Index ETF (NYSE: AMLP) now yields 7.5%, a roughly 5% spread over the rate on 10-year Treasuries. Looking at data back to 1996, a spread this large has equated to a 40% subsequent one-year return on MLPs, as investors are enticed by such compelling payouts. In fact, the spread between treasuries and pipeline MLPs has only been this high about 8% of the time over the last 18 years.
Short-Term Decisions Make These Long-Term Gains Possible
Volume for the Alerian MLP ETF has spiked as investor fear causes hedge funds to rush for the exit, despite a strong long-term outlook. The average daily volume for the ETF in 2014 to September was 3.1 million shares. The average daily volume this year has been 4.7 million shares with a recent spike sending the 10-day average to 5.5 million shares. The steep increase on large price swings tells me we could be close to the point of capitulation where sellers will have sold out and long-term buyers will support the group.
While the rest of the year could still be difficult, oil production could fall quickly into 2016. Shale drillers collected upwards of 65% of their Q1 revenue from price hedges that were bought before the collapses in oil.
Many of those hedging contracts will expire in coming quarters, which will cause drillers to re-evaluate production. Lower production will support prices while pipeline demand could actually increase as consumption increases on lower-cost oil.
A focus on midstream transportation, which typically carries less commodity price risk and makes money on volumes of oil or gas delivered, will help protect your portfolio from remaining oil price weakness. Investors should look to MLPs with a strong hedging program that covers their flow business through this year and into 2016. Look for companies that have recently raised their distribution as a sign of confidence and stability in cash flows.
Energy Transfer Partners (NYSE: ETP) raised its quarterly dividend to $1.015 per unit in May, up 8.5% since last year for a current yield of 8.1%. The increase marks the 7th consecutive quarterly increase. The partnership’s recent merger with Regency Energy Partners increased fee-based revenue by 12% to 87% of total sales. Just 13% of the partnership’s revenue is exposed to non-fee based sales and 3% of that is hedged.
Plains All American Pipeline, L.P. (NYSE: PAA) raised its quarterly dividend to $0.695 per unit in July, up 7.7% since last year for a yield of 6.9%. The increase marks the 24th consecutive quarterly increase for the partnership. The partnership highlighted the potential for a 40% drop in crude prices during the June 2014 analyst meeting and took action to position 76% of sales in fee-based services and 98% of capital spending to fee-based projects. Even if energy prices remain low for a while, the company will progressively shift towards fee-based sales for stability.
Risks to Consider: Energy production continues to increase in the United States and oil prices are likely to remain range-bound for much of this year. Even stronger names in the MLP group could be volatile until energy prices head higher.
Action to Take–> Take advantage of the panic selling in midstream MLPs to position your portfolio for a rebound. Stagger your total investment through the rest of the year to benefit from high yields and cost-average your price.
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