Energy Transfer Partners (ETP) is another of the big cap MLPs. Along with KMP and EPD it makes up a good portion of the Alerian MLP index. Like my earlier posts on KMP and EPD this post takes a look at the partnership’s historical performance and how its positioned for the future.
ETP has had a great run the last ten years like many MLPs. Since 2001 it has returned 24.7% CAGR along with a distribution growth of 11.9% CAGR over the same period. That’s slightly less than a 10-bagger over the last decade primarily driven by a high yield, high dividend growth, and the power of re-invested dividends. Just wanted to drive my dividend theme home a bit today!
How about its current valuation? The chart below shows ETP’s historical yield and spread the 10 year note versus the respective historical averages.
As you can see from the chart ETP is trading below its average historical yield but above its average historical spread to the 10 year note. This is also the case for KMP and EPD. That’s why I called those partnerships a bit pricey in those earlier posts. Of the three, ETP is trading closest to its historical yield and at the largest gap to its average spread suggesting it is the most undervalued of the three partnerships. At an absolute level, its current yield of 7% is also the highest of the three. Even looking out a bit further on the cap table of MLPs, to include WPZ, PAA, and MMP, ETP has the highest yield.
Is there a reason for ETP trading at a low relative valuation? Like any business ETP has its issues and challenges. I think ETP has two significant ones. First, it has not raised its distribution in just about 2 years. ETP is in a transition from predominantly a business focused on intrastate operations to one more heavily weighted to interstate operations. It has undertaken two large pipeline projects over the last 2 years that have yet to start contributing to its bottom line. I think this has tested the patience of investors as other MLPs have re-started or continued their distribution increases. Second, ETP has the 50% IDR general partner issue I’ve discussed in my other MLP posts. So, even when distribution growth resumes the general partner benefits more than the limited partners do.
The growth issue seems to be nearing an end. ETP’s two large pipeline projects are nearing completion and are expected to start contributing to cash flow in 2011. These are large projects and incremental cash flow growth could approach 20-30%. The general partner issue is a trickier one which has not been addressed and I’ll be watching that closely. However, as in the case of KMP, who has similar GP issues, growth to the limited partners could still be quite rewarding.
In summary, for the near future, I see ETP positioned better than KMP but not as good as EPD. All three are incredible top notch businesses with the wind at their backs but based on valuation ETP looks to be the most attractive of the three for new money. ETP reports Q3 2010 earnings next week so keep your eyes and ears open.
12 Comments
Rick · November 12, 2010 at 2:17 pm
Paul:
How can the gas service play through ETP be such a good long play while natural gas (UNG) been in such a freefall?
Rick
libertatemamo · November 12, 2010 at 3:57 pm
Hey Rick. Great question. MLPs like the three I’ve posted on (ETP, KMP, and EPD) are primarily pipeline companies. The build pipelines for oil, natural, gas, and natural gas liquids and then charge based on the volume that flows through those pipelines. The have minimal exposure to natural gas prices. If you look through any of these companies’ presentations you’ll see mention to how much of their business is ‘fee-based’. That means they get paid on volume. In this case, lower nat gas prices can actually be good for these companies if it spurs more demand. A great example of this is ethylene production. Turns out you can make ethylene (the major chemical used to make all kinds of plastics) from oil (naptha) or from natural gas (ethane). Recently with oil up and nat gas down a lot of ethylene producers are switching to nat gas based ethane as the input to their mfg. Great for nat gas volumes and processing.
This is one of the reasons I like sticking with the pipeline companies. They are very stable businesses that are mostly not subject to commodity prices. Make sense?
Rick · November 13, 2010 at 4:17 pm
Paul:
I understand and see now see why this position is a good income/growth play.
Are there MLPs that represent the interests of companies that move or transmit utilities or comodities that would fall into that portion of a portfolio, for example electricity, data or water? It looks that one could diversify a’la Monopoly and apportion a % to each side of the gameboard.
As I approach retirement and slowly remodel my portfolio, this dividend theme, has become an axis. I appreciate your simple approach and explanations.
Rick
libertatemamo · November 14, 2010 at 10:53 am
Rick, most MLPs are focused on the energy sector because of gov’t laws that restrict the MLP structure to the energy sector. There is some diversification to be had within the MLP space however. There are exploration and production MLPs (like LINE), midstream ones like we’ve discussed, and some retail/downstream ones (like APU). Then there’s diversification among energy sources; coal, gas and its derivatives, oil, ethanol, CO2. But its only the energy sector.
I’m always looking for toll-road businesses, like pipeline MLPs, with good yields and the opportunity for dividend growth.
Utilities, in general, are a monopoly like sector. There are some good ones out there but they’re pricey right now. A good one that seems to be relatively cheap is NGG, which I also own. Exelon, EXC, doesn’t look so bad either and nuclear I think has some good growth in front of it.
Anyway, I’m kind of rambling. I hope I answered your question.
Rick · November 21, 2010 at 8:20 pm
Paul:
Still looking at MLPs as part of my re-allocation plans. Would gains be taxable as individual gains or are MPL investor liable for any aditional taxes?
Rick
libertatemamo · November 23, 2010 at 9:37 am
Rick, MLPs don’t pay taxes at the corporate level so the investor is responsible for taxes. But the great thing is that majority of MLP distributions (90% for most MLPs) are considered ‘returns of capital’ are not taxed when they are distributed. The distributions reduce your cost basis in the stock and you defer your taxes until the time you sell the shares. So, they are tax deffered entities. So, those yields you’re looking at are tax deffered yields! Most MLPs have tax information on their websites that you can check out. Also check out the tax basics section on MLPs on the NAPTP website: http://www.naptp.org/Navigation/PTP101/PTP101_Main.htm
I think this will enhance their value even more when taxes go up next year. Just another reason to own MLPs.
Paul
Rick · December 28, 2010 at 6:20 pm
Paul:
Would ETFs that basket MLPs such as SVR, AMLP, MLPI, MLPG and othere be good alternatives to buying the MLP shares?
Rick
libertatemamo · December 31, 2010 at 11:51 am
Hey Rick. Sorry for the late reply. Yes, the ETFs are reasonable alternatives to investing in the MLP stocks themselves. I think the biggest advantages are that you don’t have to deal with the K-1 tax forms, if you do your own taxes, and you can hold them in an IRA with no adverse consequences. But they do have drawbacks. The fees are pretty high for ETFs, from .85% for AMLP to 1.1% for SRV. You know how I feel about fees? At a discount broker you could by all 25 stocks in the AMLP index for $250 or less. For a $50K investment, that’s 0.5%. Some of them are structured as ETNs instead of ETFs so there is some credit risk in them, though minor I think. Lastly, the biggest drawback, if you hold them in taxable accounts you lose the tax deferral benefits of the MLPs. That’s the trade-off for not having to do the K-1s. You get a 1099 at the end of the year and your MLP distributions are treated as qualified dividends. Like everything there are tradeoffs.
Rick · December 31, 2010 at 2:33 pm
PAUL:
Do you take your distributions in you MLP holdings as $ or reivested in shares? My personal goal is to take a along position reinvesting and, in about three years take the returns as $. What it appears to me to be the best way would be to buy the ETN or ETF in the IRA accounts and the MLP individual shares in a personal account. Am I anywhere in the ballpark?
BTW, NAPTP.org contains helpfull information on this interesting subject at my novice level.
A sideoff question. How about the Telecom sector? I see people that would rather go hungry than give up their wireless palm devices. I have never seen such a craze over a toy so widespread across all age groups.
This stuff is making the beeper/cell phone wave look like a ripple. Any opinions?
Rick
libertatemamo · January 3, 2011 at 11:04 pm
Rick, I reinvest all my dividends/distributions from all my stock holdings. Always. Its one of the keys to make dividend investing really work in your favor.
Your strategy of holding the individual MLPs in a taxable account and the MLP ETFs in your IRA is the right way to go. The only other choice for IRA accounts is certain MLP share classes that pay their dividends in stock vs cash, such as KMR and EEQ. I think these IRA friendly share classes are a trend in the MLP world that will continue.
As far as the telecom sector, I agree that the smartphone adoption is a huge trend that will only continue. Just not sure the best income/dividend friendly way to invest in it. Many of the companies in the sector seem overvalued so in general I’m staying far away from the sector. Although I do think CSCO and S are quite undervalued – I trade options on these guys as a speculative investment.
I prefer sectors with a positive tail wind and that are not heavily followed, like energy infrastructure.
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