Undervalued MLPs

02/05/2014 10:00 am EST

Focus: MLPS

Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Energy and utility expert Roger Conrad looks at some favorite master limited partnerships; here, the editor of Conrad's Utility Investor, discusses two MLPs that have just been added to his Lifelong Income model portfolio.

Steve Halpern: We're here with Roger Conrad, an industry leading expert in the utility, energy, and income markets, as well as editor of Capitalist Times and Conrad's Utility Investor. How are you doing today, Roger?

Roger Conrad: Real good, Steve.

Steve Halpern: Today, we're going to talk about one of the areas that you specialize in, mastered limited partnerships. Before we begin, for our listeners who are not familiar with these vehicles, could you give a brief explanation of what an MLP is and what type of investor would be looking at that?

Roger Conrad: Absolutely. It's, basically, an investment construct that enables the company to not pay any federal income tax, and it does that a variety of ways.

And, without getting too deep in the weeds on it, the end result for an investor is a yield that's much higher than would be on an ordinary common stock, because they can put a lot more money through, directly to the investor.

Because of the tremendous growth opportunities, we're seeing companies that are regularly increasing their dividends at pretty robust rates; in some cases, 10%, 15%, even 20% a year, so you have a vehicle there, that's got a lot of growth.

It's in a part of the economy that's very secure, and very much built into a long-term trend, and you get some really nice income as well, so I'd say, investors of all stripes. There's really something for everyone in this group.

Steve Halpern: Now, in your recent research, you note that some of the best positioned master limited partnerships are in the shale, and oil and gas arena today. Could you expand on that?

Roger Conrad: That's absolutely right, I mean, that's really the core of these master limited partnerships and why we've seen such robust growth.

Historically, big oil companies and producers have had assets that have been either mature, in terms of production, or cash cows, such as pipelines, and those have been, pretty much, not a core part of their business.

What we've seen with the MLPs is a lot of spin-offs, a lot of asset sales to these particular companies, and as this has happened, we've seen a tremendous growth of production in North America, because of technology of extracting oil and gas from shale, which is, basically, rocks that had trapped this energy for, really, decades.

And now, for the first time, it's not only economic to get out, but it's a lot cheaper to get out than conventional energy. America is really heading towards, very quickly, towards energy independence.

That's certainly something I thought we'd never see in my lifetime, but that is happening.

And, as America continues to grow, as this industry continues to grow, there's ever more opportunities for master limited partnerships, both on the upstream side in production, and midstream side, which is pipelines, and processing, and that type of thing, and then downstream side, which is distribution. There's many, many, many opportunities in all those areas.

Steve Halpern: Now, for those who are concerned about the potential for rising interest rates, you note that many MLPs are protected from the risk of rising rates. Could you explain that?

Roger Conrad: Yeah, basically, what you have is the structure for many of the pipeline contracts builds in an inflation adjustment, so that's one way you see earnings adjusted.

There's also very much a tie-in here, because some of these businesses are tied to the American boom of energy exporting and so forth, and rising production.

Energy prices are basically what drive inflation, and so what you have are business opportunities that increase as inflation picks up, and, obviously, in the case of companies that produce energy, they've got to, kind of, get a double benefit, because not only is there energy in greater demand, so they can produce more, but the prices go a lot higher.

So, if you look at, actually, the share price performance of MLPs versus interest rates, it's pretty definite. I mean, there's not really—there's much more connection between the S&P 500 and the Alerian MLP index—and that's because these are equities.


They do better when the economy does better, which is when the stock market does better. Sometimes that happens when interest rates are rising, sometimes that happens when interest rates are falling, but again, the common factor is the economy, so these are not really interest rate-sensitive investments, contrary to popular misconception I would say.

Steve Halpern: Now, let's look at two MLPs that you include in what you call your Lifelong Income Portfolio. First, tell us about Enbridge Energy Partners.

Roger Conrad: Okay, so Enbridge Energy Partners (EEP) basically holds a lot of pipeline for Enbridge Corporation (ENB), a big Canadian company, so they have a lot of strong backing from there.

The reason we like it is because they have a lot of projects coming on, they're very tied into the Bakken region, which we talked about, shale; that' s a very prolific area of oil production where there's not a lot of pipelines, and so forth, going on there, so they have the tremendous business opportunity.

There also has not been an increase in their distribution the last several quarters, so that's also the opportunity for tremendous upside. I think they're going to actually start increasing distributions, on a regular basis, later this year.

And, as we've seen with the example of other companies, such as Buckeye Partners last year, when a company hasn't been increasing for a while and then suddenly starts increasing, you get a very nice boost in the share price.

This company, I think, has a lot of long-term potential, as well as potential for a real near-term pop.

Steve Halpern: Now, a second MLP that earns a spot in your Lifelong Income Portfolio is Kinder Morgan Energy Partners (KMP). Could you tell us what you like about that situation?

Roger Conrad: Well, people don't really have to wait very long for growth in this one. They have about five different divisions, and at any given quarter, some will outperform, some will underperform.

But the commonality is they're continuing to increase their assets in all these various areas, from pipelines to, actually, the manufacturer of carbon dioxide, which is injected into oil wells in Texas now to increase production from old, kind of, burned out wells, so you've got a tremendous amount of just, really, built-in growth.

That's like $14 billion dollars of projects in the works over the next five years, and every time they complete a project that they have a long-term customer for, they increase the distribution off of that.

They're targeting about 5% distribution growth this year, on top of a yield of about 7%, and I think that's a pretty compelling bargain.

I really do think this is a company that has underperformed and over-delivered, pretty much, consistently throughout the last several years, so I think you're going to actually probably grow the dividend even faster than that, which, again, gives some upside to the share price.

Right now, you have, I think, a really nice opportunity to buy some of these, because of the misconception that they're interest rate-sensitive.

Steve Halpern: Now, before I let you leave, I'd like to ask you about something called I-Shares. In your latest research report, you discussed these as another vehicle within this sector that might have some advantages for investors. Could you explain what I-Shares are?

Roger Conrad: Well, what we're talking about here is, what these companies have, and, actually, we mentioned Kinder and there's a Kinder Morgan Management, and the symbol is (KMR), and, basically, what this is, it's the same thing as owning Kinder Morgan except that they pay you in shares instead of in cash.

So, you avoid some of the tax complications that MLPs have and you can make them a little bit easier to hold in IRAs. They're actually trading, in the case of KMR, at something of a discount to KMP, the limited partnership, so you get a little bit higher yield, as well as, I think, a less hassle way to own it in an IRA.

Steve Halpern: Well, thank you for joining us. We appreciate your time today.

Roger Conrad: Thanks, Steve.

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