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MLP Investing: Turnaround Tales

By Roger S. Conrad on May. 10, 2013

A growing dividend is one sign of a secure payout and a healthy underlying business. And with income-seeking investors arguably more focused on safety than ever before, it’s no great surprise dividend growth commands an historic premium in the stock market.

Pick your industry. Electric utility Entergy Corp (NYSE: ETR) hasn’t raised its dividend since April 2010 and has given up about 16 percent of its value to date, compared to the roughly 16 percent return posted by the Dow Jones Utility Average over the same period. Meanwhile, shares of fellow electric utility Southern Company (NYSE: SO) have delivered a total return of 64 percent, fueled in part by four dividend increases over the past three years.

The Alerian MLP Index, a capitalization-weighted composite of 50 energy-focused publicly traded partnerships, has returned 220 percent since the stock market bottomed in March 2009. Within this popular security class, there’s a marked performance gap between master limited partnerships (MLP) that have raised their distributions consistently and names whose growth has stalled.

Blue-chip MLP Enterprise Products Partners LP (NYSE: EPD) has boosted its distribution in 35 consecutive quarters. These payout hikes not only increase the stock’s current return but also drive price appreciation: Since March 2009, units of Enterprise Products Partners have generated a gaudy return of 334 percent.

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

Buckeye Partners LP (NYSE: 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 itw distribution. In subsequent weeks, the MLP’s unit price plummeted to a low of about $45.00 after hovering around $65.00 for more than a year.

What caused this setback? The company had pursued 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.

In response, several Wall Street analysts downgraded the stock and lowered their earnings estimates. Moody’s Investor Service slashed its outlook for Buckeye Partners to negative, citing “concerns that leverage could remain elevated through at least 2012.” The credit-rating outfit also attributed the downgrade to “acquisitions paid at high multiples and lagging operating performance,” as well as elevated “event risk” from the expansion moves.

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-to-1 margin.

By the time the partnership announced these results in early February 2013, the stock had started to rebound in response to the improving safety of the quarterly payout and in anticipation of a resumed distribution growth.

Buckeye Partners’ first-quarter results built on this success. Increased capacity on the MLP’s refined-product pipelines and at its storage facilities generated enough cash flow to cover the distribution by a margin of 1.2-to-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 percent from year-ago levels. In a conference call to discuss the MLP’s results, management 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 units of Buckeye Partners have recovered nicely from their nadir, the stock still sports a distribution yield of more than 6 percent–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 for units of Buckeye Partners as the market grows more comfortable with the MLP’s return to growth.

Will NuStar Energy enjoy a similar turnaround? The MLP’s distribution coverage has slipped to less 100 percent in several consecutive quarters; in the first three months of 2013, for example, the partnership’s cash flow covered only 64 percent 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 Partnership’s 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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