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  • Roger S. Conrad

MLP Madness

By Roger S. Conrad on Dec. 2, 2015

With the Alerian MLP Index yielding almost 8.7 percent and trading below its average price to operating cash flow for the past 10 years, this basket of 50 prominent master limited partnerships (MLP) has undergone a swift rerating over the past year.

At these levels, units of many MLPs appear to have priced in significant distribution cuts. What qualities separate the merely challenged from the likely cutters? Investors should keep a close eye on near-term debt maturities, distribution coverage ratios and headwinds that could erode cash flow generation, from expiring hedges to challenging contract renewals.

Some names that feature all the hallmarks of distribution cutters could end up maintaining their payouts if they have a supportive general partner to help them through these trying times.

American Midstream Partners LP (NYSE: AMID), Southcross Energy Partners LP (NYSE: SXE) and Midcoast Energy Partners LP (NYSE: MEP) fall into this camp, though this trio of MLPs is a sure bet to cut their distributions if their sponsors ever waver in their support. Although these partnerships may maintain their payouts in the near term, their inferior asset bases make them Sells over the long term.

Upstream MLPs appear to be the most at risk of future distribution cuts, even though 11 of the 12 names in this universe have already slashed their payouts. Breitburn Energy Partners LP (NSDQ: BBEP), Linn Energy LLC (NSDQ: LINE), Mid-Con Energy Partners LP (NSDQ: MCEP) and New Source Energy Partners LP (OTC: NSLP) have already eliminated their distributions.

But we wouldn’t be surprised if Atlas Resource Partners LP (NYSE: ARP), EV Energy Partners LP (NSDQ: EVEP), Legacy Reserves LP (NSDQ: LGCY), Memorial Production Partners LP (NSDQ: MEMP) and Vanguard Natural Resources LLC (NSDQ: VNR) were to reduce their payouts even further or eliminating them entirely.

We see no reason for investors to add exposure to these names; Breitburn Energy Partners’ units gave up another 35 percent of their value after the MLP eliminated its payout.

Distribution cuts could also be in the cards for SeaDrill Partners LLC (NYSE: SDLP) and Transocean Partners LLC (NYSE: RIGP), as customers continue to pressure offshore contract drillers to renegotiate contracts.

Fixtures in this industry also tend to involved shorter terms (three to five years), creating significant renewal risk. And these partnerships’ elevated costs of equity capital make additional asset acquisitions a challenge. SeaDrill (NYSE: SDRL) and Transocean (NYSE: RIG) also face their own financial challenges that likely will constrain them from stepping up to support the MLPs under their auspices.

As for the midstream side of the equation, ONEOK Partners LP (NYSE: OKE) could be at risk of a clandestine distribution cut if ONEOK (NYSE: OKE) takes a page out of Kinder Morgan (NYSE: KMI), Crestwood Equity Partners LP (NYSE: CEQP) and Targa Resources Corp’s (NYSE: TRGP) playbooks and acquires the MLP. (See MLPs: Evolution, Not Extinction.)

All three of these previous transactions effectively reduced unitholders’ quarterly income by varying degrees.

Investors should also steer clear of Azure Midstream Partners LP (NYSE: AZUR), which owns gathering and processing assets in out-of-favor basins where producers continue to scale back their operations and some marginal names find themselves under considerable strain. Renewal and counterparty risk don’t bode well for the MLP’s distribution. The CFO’s abrupt departure also doesn’t inspire confidence.

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