Big Income from a Turnaround Tale

05/28/2013 9:45 am EST

Focus: MLPS

Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

After a few quarters in the doldrums, this energy MLP's fortunes are on the rise, says Roger Conrad of Energy & Income Advisor.

The Alerian MLP Index—a capitalization-weighted composite of 50 energy-focused publicly traded partnerships—has returned 220% since the stock market bottomed in March 2009.

But there's a marked performance gap between master limited partnerships (MLPs) that have raised their distributions consistently and names whose growth has stalled.

Blue-chip MLP Enterprise Products Partners (EPD) has boosted its distribution in 35 consecutive quarters, which has increased the stock's current return, but also driven price appreciation. Since March 2009, units of Enterprise Products Partners have generated a return of 334%.

In contrast, NuStar Energy (NS), which hasn't raised its quarterly payout since July 2011, has given up more than 20% of its value over this period.

Buckeye Partners (BPL) used to fall into the category of distribution disappointers. In early May 2012, the owner of refined-products pipelines and terminals broke a string of 31 consecutive quarterly increases to its distribution. In subsequent weeks, the MLP's unit price plummeted to a low of about $45, after hovering around $65 for more than a year.

This setback was due to pursuing an ambitious slate of acquisitions and asset expansions that had yet to produce the anticipated level of cash flow, resulting in a shortfall that raised speculation that the firm might cut the distribution. Several analysts downgraded the stock and lowered their earnings estimates, and Moody's Investor Service slashed its outlook to negative.

However, the first quarter of 2012 marked the nadir of Buckeye Partners' fortunes, as improving operating performance fueled a recovery in the MLP's distributable cash flow (DCF). In fact, a strong fourth quarter enabled the publicly traded partnership to cover its full-year payout by a 1.04:1 margin.

The stock began rebounding in response to the improving safety of the quarterly payout and in anticipation of a resumed distribution growth.

In Buckeye Partners' first quarter, increased capacity on its refined-product pipelines and at its storage facilities generated enough cash flow to cover the distribution by a margin of 1.2:1. The partnership also appears to have settled a dispute over pipeline tariffs with Federal Energy Regulatory Commission.

These improvements enabled Buckeye Partners to increase its first-quarter distribution by 1.2% from year-ago levels. Management has left little doubt about its commitment to increasing the quarterly distribution at regular intervals. Much of this upside will come from the $130 million that the partnership allocated to growth projects in 2012 and an expected $200 million to $235 million in capital spending this year.

Although Buckeye Partners has recovered nicely, the stock still sports a distribution yield of more than 6%—well above the current return offered by other midstream MLPs that generate the preponderance of their cash flow from fee-based contracts. We foresee additional upside, as the market grows more comfortable with the MLP's return to growth.

As for NuStar Energy, the MLP's distribution coverage has slipped to less than 100% in several consecutive quarters. In the first three months of 2013, the partnership's cash flow covered only 64% of its payout.

Nevertheless, management maintains that the deconsolidation of the MLP's asphalt business and the addition of fee-generating energy storage and transportation assets will bridge this shortfall by the end of 2013.

A year ago at the National Association of Publicly Traded Partnerships' annual investor conference in Greenwich, Conn., NuStar Energy's CEO, Curtis Anastasio, reassured attendees that the MLP's restructuring efforts eventually would enable the firm to grow its distribution at an above-average rate.

Elliott and I will pay close attention to management's presentation at this year's conference to see if this outlook has changed.

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