With the end of Q1 2011 upon us, and earnings reports to start coming soon, I thought it was a good time to re-look at MLP valuations, specifically the top 5 market cap MLPs and the Alerian MLP index. I posted on year end 2010 values in this post. Below are two tables showing the valuation of the top 5 MLPs; EPD, KMP, ETP. WPZ, and PAA. The top table shows the valuations from year end, reproduced from my earlier post, and the bottom table shows the current valuations.
As the bottom table shows, MLP valuations are up across the board from the end of 2010. Both absolute yields and spreads are down across the board. With respect to historical valuations MLPs also became slightly more expensive as shown in the discount/premium columns. On a relative basis, KMP and ETP remain the lowest valued big cap MLPs, while WPZ and EPD remain the highest valued. Historical MLP valuations have gone higher in the past, so valuations can go higher from here, but as I’ve said before the sector in general look slightly frothy. For investors looking to put new money to work KMP, or even better KMR shares, or ETP shares offer the best value in today’s market. KMR shares represent the same economic interest as KMP shares but trade at an 11% discount to KMP shares. For investor with existing MLP positions patience in putting more money into the MLP space is in order. Better values will probably emerge in the future.
On the relative valuation front, there are some very good reasons for the discrepancies in valuations between the large cap MLPs. Both KMP and ETP have issues that are worrying investors. KMP has two issues; the KMR share discount relative to KMP, and more importantly the high GP splits that go to its general partner KMI. ETP has suffered through a massive fundamental change to their business and has not grown distributions in over 2 years. Its new growth projects are just coming on line and it should re-start distribution growth this year but I think investors are being cautious. Also, both KMP and ETP have distribution coverage ratios just above 1x, by design in the KMP case, by necessity in the ETP case. On the other hand, EPD’s business is firing on all cylinders. It bought out its general partner EPE and subsidiary DEP. It has the lowest cost of capital among the big MLPs. Also, its distribution coverage ratio is about 1.3x. In general it seems the share prices reflect these discrepancies.
Finally, I cringe as I write this but…. this time could be different! Those are usually very dangerous words when dealing with investments. But I think its important to point out. The rise in MLP valuations could just be reflecting their rise as a new asset class with wider investor interest and thus higher valuations are justified. Maybe. I can easily make a very bull case in support of this argument. For example. why should MLPs trade at a discount to utilities, which pay yields of about 4%, when their fundamentals are clearly better. Is it solely due to the MLP tax issues? Maybe. I’m not ready to jump into this boat but it is an argument to keep in mind. If this argument starts to take hold MLP yields could approach 4%. That’s a 30% plus upside from today’s levels. Just saying….
On another note, most MLPs have just had their annual analyst meetings and have posted those presentations to their websites. I highly recommend downloading those presentations. I was particularly impressed with KMP and EPD’s presentations.
In summary, MLP valuations are frothy but could go higher. I think there are spots for investors to put new money to work but existing investors are probably better off waiting for better values. With earnings season approaching I’ll be writing up results for the big cap MLPs in the near future.
Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.