There are many reasons leading to the 2017 underperformance of MLPs relative to other sectors. One of the main reasons is the decline in the per-unit distributions and slower cash flow growth. Another reason might be the tax loss selling by institutions by Nov 30 fiscal year-end for reporting purposes resulting in selling pressure. Late October’s introduction of Tax Reform and risk relating to Internal Revenue Code section 7704 gave investors reason for pause, which added to sector pressure. In addition to prior distribution cuts occurring with KMI, PA, WPZ, there was distribution cut in Oct with GEL.
The cut was as a result of high dividend yield almost 11% (a high distribution yield implies a high cost of equity capital), high leverage (due to massive acquisition and growth capital spending), and the issuance of preference shares. In addition, EPD, a stock in Camarda’s Strong Stock portfolio, announced to reduce distribution growth, not a distribution cut. The reduction in the distribution growth is to free up cash flow to cover its growth budget. By slowing down the growth rate of its distribution, EPD hopes to better fund both its current payout (current distribution yield is 7%), and its capital expenditures. The EPD’s action may open the door for other companies in the sectors to follow suit. So a key way for many MLPs to reduce distribution (growth) is to retain cash organically to fund growth budgets, instead of issuing additional stock units or borrowing more. In this way, they can reduce interest expense and strengthen their balance sheets, which is positive for them in the long-term.
Currently, Camarda has three MLPs in the SS portfolio: MMP, BPL, and EPD. The three companies saw an increase in operating cash flows over the past 5 years. Leverage is not high. These companies do not offer incentive distribution rights (IDRs) which gives the general partner an increasing proportion of an MLP’s cash distribution as it grows. This is a key attribute, since it preserves a higher percentage of cash flow for distribution to investors by controlling high management costs. Many MLPs are saddled with IDRs, a negative for the entire sector, but an opportunity for Camarda to help its clients find value by targeting non-IDR MLPs. On a YTD basis, companies that don’t have IDRs significantly outperformed those that do. Of important not, currently there are only six MLPs without IDRs. In conclusion, the poor performance of MLP sector has given good opportunities to invest in companies with defensive asset bases, good geographical foot prints, supportive sponsorship and lack of IDRs.
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