Chinese Stocks Enter Bear Market for Second Time in Seven Months

01/15/2016 9:49 am EST

Focus: MLPS

Michael Berger

President & Founder, Technical420.com

Energy stocks were amongst the hardest hit by China’s sell-off Friday and Michael Berger, of Technical420.com, expects to see this create a ripple effect on United States energy stocks. However, Michael still has a positive long-term outlook for the MLP industry and highlights several names to watch.

For the second time in seven months, Chinese stocks entered into a bear market (as defined by a 20% drop) after the Shanghai Composite Index fell 3.5% Thursday. The index has fallen more than 20% since December 22 and it is trading below its closing low during a $5 trillion rout in August.

Friday’s weakness was attributed to concerns over volatility in the yuan and a report that some banks in Shanghai have stopped accepting shares of smaller listed companies as collateral for loans. This wiped out the gains from an unprecedented state rescue amid less confidence in the government’s ability to manage China’s markets and its economy. The sell-off is a setback for China’s policy makers who have tried to support both stocks and the yuan after the worst start to a year in at least two decades.

Energy Stocks Lead Sell-off in China

Energy stocks were amongst the hardest hit by China’s sell-off on Friday and we expect to see this create a ripple effect on United States energy stocks. Thursday, several master limited partnerships (MLPs) rallied off of recent lows and we expect to see them give up their gains after both WTI Crude and Brent Crude broke below $30 a barrel Friday morning.

Out of the MLPs we are favorable on Energy Transfer Equity, L.P. (ETE), the biggest mover Thursday with shares up more than 23%. On Wednesday, ETE traded at a new 52-week low ($7.39). Thursday’s move broke shares out of oversold territory and we expect to see ETE give up a good portion of its gains Friday and test its lows from Wednesday.

We remain favorable on the long-term outlook of ETE because the company offers investors an attractive total return due to its exposure to underlying cash flow growth from: 1) Energy Transfer Partners (ETP), 2) Williams Partners (WMB), 3) Sunoco Logistics (SXL), 4) Sunoco LP (SUN), and 5) Lake Charles LNG project.

Three Things Must Happen for Midstream MLPs to Rally

The lack of near-term catalysts will continue to be a headwind for the MLP industry as the price of oil remains low. That being said, we expect to see the price of oil rally in the second half of 2016.

When it comes to midstream MLPs, several things must happen in order for equities to rally. These include: 1) the market must have tangible supporting data to get more comfortable that oil has bottomed; 2) the market must digest 2016 operational forecasts and reduced growth capital expenditures assumptions. This is very important because it will influence how midstream operators outline their 2016/2017 growth capital expenditures; and 3) midstream operators must address the structural constraints on capital allocation and outline their financing plans that have adapted to the higher cost of capital environment.

Partnership to Watch

While we acknowledge the potential for the MLP industry to continue to trade weak, we have a positive outlook on Tesoro Logistics LP (TLLP). During the last six months, TLLP has fallen more than 18%. Although this drop seems significant during this period, TLLP has outperformed the Alerian MLP Index (AMZ). AMZ is comprised of a diversified group of 50 MLPs and is often used to measure the strength of the industry. During the last six months, AMZ has fallen more than 36%.

Our investment thesis for TLLP is based on: 1) a stable and visible base cash flow profile, 2) strong support from its sponsor, Tesoro Corporation (TSO), 3) strong balance sheet, 4) ample liquidity to capitalize on accretive acquisition opportunities, and 5) low-capital intensive long-term organic growth outlook. TLLP’s low-risk asset base, coupled with a supportive sponsor, provides the company with one of the most compelling growth stories in the MLP industry.

Michael Berger, Founder and President, Technical420.com

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