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In summer 2009, the US stock market started to recover from the ravages of the worst global economic downturn and financial crisis since the Great Depression.
The rebound was swift and dramatic. From its low on March 6 through mid-October, the S&P 500 surged by more than 53 percent as evidence mounted the credit crunch had eased and the US economy had begun a tentative recovery.
As is so often the case, the S&P 500 was a leading indicator for the US economy, finding a bottom about three to four months before the recession officially ended.
The Alerian MLP Index, which suffered the vicious one-two punch of collapsing commodity prices and severe liquidity constraints, bested the S&P 500’s total return by a margin of almost 15 percent.
In spring 2009, bargains abounded in the master limited partnership (MLP) space and even rock-solid, large-cap names such as Enterprise Products Partners LP (NYSE: EPD) offered mouth-watering yields of 12 percent or more.
As co-founders of the first financial advisory focused solely on publicly traded partnerships, Roger Conrad and I took advantage of the sector-wide bargains, highlighting more than a dozen high-yield MLPs that soared as the market found a low.
However, the market’s rising tide lifted all boats, including a number of low-quality MLPs that deserved a re-rating in the opposite direction.
Consider K-Sea Transportation Partners LP, a publicly traded partnership that owned a fleet of tanker barges used to transfer oil and refined products between coastal ports. The stock traded in the mid-$40s in 2007 and consistently ranked among the highest-yielding MLPs in our coverage universe.
Even with the post-crisis rally picking up stream in summer 2009, K-Sea Transportation Partners’ units still offered a current return of about 16 percent—roughly double the Alerian MLP Index’s yield.
This sky-high payout made K-Sea Transportation Partners a popular holding among individual investors, though Roger and I maintained a Sell rating on the stock.
Attendees of financial conferences often asked why we were so down on K-Sea Transportation Partners; after all, the MLP had survived the Great Recession without cutting its payout. Others asked whether the stock’s super-sized yield had already priced in a potential distribution cut and any other bad news.
Too many investors focused on yield and ignored the fundamental challenge that K-Sea Transportation Partners faced: The long-term contracts covering the MLP’s legacy barges began to expire in mid-2009, and the firm was unable to obtain similar rates on new agreements.
This headwind forced the MLP to cut its quarterly distribution from $0.77 per unit in August 2009 to $0.45 per unit in November 2009. On that day, the stock plummeted almost 38 percent.
K-Sea Transportation Partners suspended its payout entirely in early 2010, sending the stock to an all-time low of less than $4 per unit. Kirby Corp (NYSE: KEX) in March 2011 acquired K-Sea Transportation Partners for about $8 per unit.
K-Sea Transportation Partners’ stock gave up about 82 percent of its value in the 12 months after the MLP slashed its distribution, making the name one of the worst-performing publicly traded partnerships in a bull market for the space.
Today, upstream operators—outfits that produce oil, natural gas and natural gas liquids—offer some of the highest yields among energy-related MLPs.
The Yorkville MLP Exploration & Production Index, which tracks the 14 publicly traded names that fall into this category, has given up 50.7 percent of its value this year and sports a dividend yield of 19 percent.
Linn Energy LLC (NSDQ: LINE), the largest upstream MLP by market capitalization, offers an indicated yield of 26.8 percent, having sold off precipitously with the drop in oil prices.
By comparison, the Alerian MLP Index, a capitalization-weighted basket of 50 prominent publicly traded partnerships, sports a current return of 5.8 percent.
In Energy & Income Advisor, we told readers to take advantage of the modest bounce in these names to exit their positions, as a challenging environment for commodity prices and lack of liquidity in the futures market will pressure cash flow and distributions.
Moreover, even Memorial Production Partners LP (NSDQ: MEMP) and Vanguard Natural Resources LLC (NSDQ: VNR)—the best houses in a bad neighborhood—would sell off further if a higher-risk name such as Mid-Con Energy Partners LP (NSDQ: MCEP) were to cut its payout.
As in summer 2009, many readers have asked whether it’s too late to sell their upstream MLPs, with some even suggesting that Linn Energy’s units could rally if the MLP were to slash its payout next year. According to this logic, the stock’s 26.8 percent yield has already priced in a significant distribution cut, leaving little room
But before you go dumpster diving in the upstream MLP space, consider the painful case of K-Sea Transportation Partners and study our table tracking the fortunes of the 17 energy-related partnerships that took an axe to their distributions over the past six years.
History doesn’t support the notion that investors should look to buy MLPs before they cut their payouts.
Of the 17 names in our survey, 14 suffered a further decline in their unit price on the first trading day after announcing their new distribution policies. On average, these 17 MLPs gave up 19 percent of their value the day after unveiling their lower payouts and tumbled by almost 27 percent in the six months following these announcements.
These averages overstate how MLPs have performed following a distribution cut.
For example, when Inergy LP—now Crestwood Equity Partners LP (NYSE: CEQP) after a complicated merger—on April 26, 2012, slashed its quarterly payout to $0.375 per unit from $0.705, its unit price popped almost 16 percent the day after the announcement.
In reality, the real damage occurred on Jan. 27, 2012, when Inergy’s management team disclosed that a distribution cut could be in the offing; the stock gave up 24 percent of its value that day.
Even in instances when analysts and investors expect a distribution cut, MLPs usually underperform after these fears come to fruition.
The average partnership on our list of cutters gave up more than 30 percent of its value in the six months prior to announcing the move to a lower payout. And the day before going public with plans to slash their distributions, these names sported an average yield of more than 25 percent—a clear sign of trouble.
Dumpster divers beware: MLPs that slash their distribution tend to underperform the Alerian MLP Index before and after they announce reductions to their payouts.
The MLPs in our study usually bottomed three to six months after the initial announcement, tumbling an average of 27 percent after delivering the bad news to investors and about 5 percent a year after moving to a lower payout.
Barring an unlikely recovery in crude-oil prices, some upstream MLPs will need to cut their distributions in 2015.
Our outlook calls for West Texas Intermediate crude oil to slip to about $40 per barrel next year—a level that would prompt more producers to reduce output, likely in marginal fields or basins that are geographically disadvantaged. (See Game Plan for Lower Oil Prices.)
History suggests that investors should wait at least a few months after an upstream MLP cuts its distribution to consider establishing a position. Although these names have pulled back dramatically, investors who rush in could find themselves saddled with additional losses. Steer clear for now.
Elliott and Roger on Jun. 28, 2018
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Our take on more than 50 energy-related equities, from upstream to downstream and everything in between.
Our assessment of every energy-related master limited partnership.
Roger Conrad’s coverage of more than 70 dividend-paying energy names.