A Good Time to Buy MLPs
08/27/2013 12:00 pm EST
A modest tapering of the Fed's stimulus could come next month and produce a temporary rally in a variety of income vehicles writes MoneyShow's Jim Jubak, also of Jubak's Picks.
I think this is a good time to be buying—selectively—income-producing MLPs (master limited partnerships). I'm less enthusiastic about REITs (real estate investment trusts): There are good buys in the sector, but you have to be even more selective than with MLPs.
I'm going to explain how you go about being selective in buying MLPs and REITs.
On September 18, I think the Federal Reserve will begin to reduce its monthly purchases of Treasury and mortgage-backed securities. About 65% of economists surveyed by Bloomberg on Aug. 21 agree with that opinion.
The consensus is that the taper will begin with a reduction in the $85 billion in monthly purchases to something like $75 billion or $70 billion. My suspicion is that a reduction of that magnitude won't have much effect on the financial markets. In fact, my suspicion is that the reaction will be "That's what we were worried about?" and that we'll get, at least, a temporary rally in bonds, dividend-paying stocks, and other income vehicles. (Temporary. Remember that the markets also have to cope with the threat of a government shutdown in September over the budget, and a potential debt ceiling crisis in October.)
If my suspicion is correct, right now is a good time to pick up shares of dividend-paying companies and units of MLPs and REITs. After the drubbing dealt out to income assets in the last month, it's relatively easy to find dividend stocks that pay 5.24%, as Teco Energy (TE) did at the August 23 close or MLPs paying 5.72%, as ONEOK Partners (OKS) did on that date.
But I'd like to have more than suspicion in my corner before buying anything in the income sector now. Yes, it stands to reason that a taper to $75 billion from $85 billion won't be a big deal, and that income assets are now oversold, but I wouldn't mind buttressing that suspicion with as many other advantages I can find.
And, fortunately, I can find two that suggest where the biggest and safest bargains lie in the income sector.
First, I'd like to see income assets where the price has been driven downward by more than just fear of the taper. For example, part of the reason I recently added Teco Energy to my dividend-income portfolio is that the company's coal subsidiary has been hit hard by falling coal demand and lower prices, providing a second negative trend in addition to the more general fear of a Fed taper.
Second, I'm looking for stocks with a second or third negative trend playing against them if, and only if, I think that trend is likely to reverse soon. So I looked to buy Teco Energy because the company is planning to sell its Teco Coal unit. That sale would remove one of the problems depressing Teco Energy shares and give the stock a very good chance of rising, even if my suspicion on the market reaction to a taper turns out to be wrong or overstated.
In other words, I'm looking for income assets with their own specific reasons for appreciation, rather than just trusting to a hope that a rising tide will lift all boats.
I think the natural-gas boom in the United States has made for especially attractive hunting in the energy MLP sector. And within that sector, I'd target MLP pipeline companies with big exposure to natural gas liquids.|pagebreak|
You're probably familiar with the way that the natural-gas-from-shale boom in the United States—following on slack demand resulting from the global financial crisis—has driven down the price of natural gas in the United States. Natural gas prices, which had touched $13 per million BTUs (British thermal units) in June 2008, plunged to $2 per million BTUs in 2012, before beginning a recovery that put the September futures at $3.54 per million BTUs as of August 23.
With producers not making money at that level, they cut back on natural gas exploration, and production, and increased production, of natural gas liquids, such as ethane, propane and butane that were in demand from the chemical industry. At Chesapeake Energy (CHK), natural gas production was flat in the second quarter but production of liquids—oil and natural gas liquids—climbed so that liquids made up 25% of production in the quarter, up from 21% in the second quarter of 2012. (Chesapeake Energy is a member of my Jubak's Picks portfolio.)
As you might imagine, this wholesale shift in the sector has resulted in a surge in supply of natural gas liquids and a drop in price. Natural gas liquids, which sold for better than $40 a barrel in December 2012, dropped to $33 in June. That resulted in pain, not just for producers, but also for pipeline companies. While some companies were relatively sheltered from the price drop, because a majority of their natural gas liquid transmission business consisted of fixed-fee contracts that didn't rise or fall with the price of gas, no pipeline company totally escaped. For example, second-quarter results at ONEOK Partners were hit by ethane rejection. The price of ethane had dropped so far that it no longer paid to separate ethane from other liquids at the field, so that the resulting liquids shipped through the pipelines were a less-valuable mixture of liquids rather than purer and more-valuable ethane, or propane, or whatever. In the first quarter of 2013, spreads between ethane and propane basically collapsed at ONEOK to just a penny a gallon. That led to a huge miss, as earnings came in at 42 cents a unit instead of the 58 cents projected by Wall Street analysts. In the second quarter, a rebound in ethane/propane spreads to 6 cents a gallon, contributed to an 8 cents a unit earnings surprise. (ONEOK is a member of my Dividend Income Portfolio.)
So why does all this bad news about natural gas liquids equate to a reason to buy specific energy MLPs?
First, because the supply of natural gas liquids has led to a big need for investment in pipelines, fractioning plants, and export facilities for natural gas liquids. Remember, one of the things that you're looking for when you evaluate an MLP is the future stream of investment opportunities. Yes, you certainly want an MLP that can raise cash at a reasonable price, but you also need to make sure that this MLP has enough places to put the cash.
That's certainly the case with energy MLPs in the natural gas liquids sector. Look at the pipeline at Targa Resources Partners (NGLS), for example. (Targa is a member of my Jubak's Picks portfolio.) Targa has just completed the fourth train of a fractionator that should fully contribute to revenue in the fourth quarter. Phase 1 of the Galena Park propane export expansion is on track for completion in the third quarter. The Longhorn, SAOU, and Sand Hill projects are ramping toward full completion. and the High Plains plant is set for completion in mid-2014.
Prices for natural gas liquids have recovered slightly, climbing to $37 in mid-August. I think that's connected to a rally in the price of oil, that may be only temporary. But looking at basic supply and demand (created by projects such as the expansion of export facilities) I think investors are likely to see a sustainable increase in the price of natural gas liquids in 2014 and 2015.|pagebreak|
Buying energy MLPs with exposure to natural gas liquids now means that you'll pick up, not just the current high yields, but capital appreciation from the recovery in natural gas liquid prices. My two top picks in this sector are Targa Resources and ONEOK Partners. A step down would come Kinder Morgan Energy Partners (KMP). All three are members of my Dividend Income portfolio. They pay yields of 5.76%, 5.73%, and 6.32%, respectively.
I'm not as enthusiastic about REITs as I am about energy MLPs, because I can't find any supportive trend for REITs, like these energy MLPs receive from natural gas liquids. The case for buying REITs right now rests, pretty much, on the foundation of my suspicion that the market has overreacted to prospects of a Federal Reserve taper, and that once the taper is actually announced, we'll see a rally in income assets.
That said, although I'd rather buy energy MLPs here, there are REITs with attractive current yields and with diversified real estate portfolios that are worth a look, just on the yield story alone.
One of the most interesting to me is 2013 Agellan Commercial REIT, which trades under the symbol (ACR-UN) in Toronto. The current portfolio consists of 24 commercial, office, and industrial properties in Texas, the Midwest, and Ontario. The yield is 8.47%.
Of course, if you're looking for a REIT with a possible supportive trend you might try Keppel REIT, trading in Singapore under the symbol (SP:KREIT) (US:KREVF). The units dropped on fears that worries over the real estate market in China would infect real estate prices in Singapore. If you think those worries are overblown—and I do—you might take a look at this REIT with its 6.68% yield. (Note that Singapore has a 0% withholding rate for overseas investors.)
Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund did own shares of Chesapeake Energy and Keppel REIT as of the end of June. Click here for a full list of the stocks in the fund as of the end of June.