Igor Greenwald The Wealth Summit May 2014 Do You Like Sausage I know I do let me count the ways Grilled with onions Smoked with sauerkraut On a stick fried in pancake batter ID: 237310
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Slide1
Inside the MLP Factory
Igor Greenwald
The Wealth Summit
May 2014Slide2
Do You Like Sausage?Slide3
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.)Slide4
What does sausage have to do with master limited partnerships?
Only this:
The end result is much more appealing than the preparation processSlide5
Why the bad rap for sausage factories?
“If you like laws and
sausages,You should never watcheither one being
made.” ─ Otto von Bismarck, maybeAnother thing The Iron Chancellor
probably didn’t say:“If you like pithy quotes, don’t
worry too much about attribution.”
Blame this
man:Slide6
How are MLPs like laws and sausages?
Complex process
Assembled by specialistsDefects hard to spot
Fill a need for the publicProducers can profit by fooling consumersSlide7
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
Slide8
And yet, here’s what we know:
Sausage is tastyLaws keep anarchy at bay
MLPs have been the best investment so far in this centurySlide9
Deal of the CenturySlide10
Source: Pension Consulting AllianceSlide11
Source: Pension Consulting AllianceSlide12
Source: Pension Consulting AllianceSlide13
Source: Pension Consulting AllianceSlide14
How Fresh Is That Sausage?
Past performance does not predict futureOutperformance won’t last forever
Risk of reversion rises over timeThe role of sentiment in market cycles Slide15
Reality Check
Source: William BlairSlide16
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 Slide17
No Contest
Source: AlerianSlide18
Drill, Baby, Drill
Source: US Energy Information Administration
Projected US energy productionSlide19
Moveable Feast
Source: RBN Energy
Government shale forecasts keep missing lowSlide20
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 HowardSlide21
The Price of SuccessSlide22Slide23Slide24
MLP Bulls Come Lately
New investment vehicles by year of launchSlide25
Drilling for Cheap Capital
Source: Hinds HowardSlide26
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)Slide27
Devon’s Sweet Deal Slide28
Devon valued (still!) at less than 5x EV/EBITDA
Deal valued auxiliary midstream assets at 11x EBITDADevon’s contribution to MLP valued at $4.8 billion
Market has since repriced to more than $7 billion, or 16x EBITDAMLP trading at three times
Devon’s cash flow multiple
MLP AlchemySlide29
PSX vs. PSXP
PSXEV = $49.3B
EBITDA = $3.4BEV/EBITDA = 14.5
The high cost of the extra “P”
PSXP
EV = $3.5B
EBITDA = $67.7M
EV/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
Slide30
A Different YardstickSlide31
Bonds Have More Fun
Fixed income in fourth decade of bull market
Government bonds don’t have business riskOn 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 misleadingSlide32
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 costlySlide33
The MLP Profits Philosophy
We recommend investments, not tax shelters
We do so based on long-term fundamentals, not yieldWe’re bullish on many strong MLPs and GPs
But we’re also not afraid to sell and criticizeOr to admit mistakes and change course
Slide34
Strong Performance Record
Last year’s picks returned nearly 40% annualized by year-end
Portfolio comfortably beat MLP benchmark as well as S&P 500Timely buys:Energy Transfer Equity (ETE) +66% since 6/7/13
EQT 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 5/29/13
Boardwalk Pipeline Partners (BWP) -42% since 11/15/13
Timely re-buys:
Boardwalk Pipeline Partners (BWP)
+15%
since
4/4/14
Slide35
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)Slide36
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 Slide37
Let’s Talk Incentives
Incentive 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 unitStated rationale: incents GP to grow MLP
Unmentioned: dilutes rewards of growth for limited partnersPerverse: 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
Slide38
Follow the Bouncing IDRsSlide39
In Summary
MLPs in sweet spot of domestic energy boom
Lofty valuations suggest increased risk
Downside from higher rates, lower energy pricesReturns can be tasty, but insiders eat first
We watch sausage get made so you can enjoySlide40
Thank You.