Update on MLP valuation

Well, the MLP correction I discussed earlier seems to have run its course for now. I thought this would be a good time to see what this correction has done for MLP valuations relative to history. I last did this back at the end of Q1 2011 and was planning to hold off until the end of this quarter but I thought readers would be interested in a more timely update considering the recent drop in MLP prices.

First, a few words on the correction. The MLP index, AMZ, hit bottom on May 17th at 351.19 representing a correction of -9.96% from its recent peak of 390.02 on April 28th. As of May 2oth it was at a level of 365.90 still leaving it -6.9% of the highs. To put things in historical perspective the AMZ has corrected over 10% 7 times in its history, over 25% 3 times, and over 40% one time. All in all this was not a major correction given its history. The range of corrections for the individual MLP names was quite broad even among the large cap names with KMP correcting -6.49% and ETP correcting -14.6%.

As for valuations, the table below shows my updated valuation table for the AMZ index and the top 5 MLPs by market cap. The top section shows the values from the end of Q1 2011 and the bottom section shows the recent values using prices as of the close on May 20 2011.

The most recent data shows that MLPs have increased in yield, dropped in price, showing the results of the correction but are still trading below their historical yields. However, they are now trading slightly above their historical spread. By this metric they are fairly valued. This is mainly due to the drop in 10yr treasury yields in the last month. While it would be great to have both metrics flashing green this is an encouraging sign particularly if you expect the low interest rate environment to continue.

As for the individual MLP names, all are less expensive than at the end of Q1 2011 and ETP and KMP still represent the best value. As a matter of fact, ETP now trades at both a discount to its average yield and average spread. Its the least expensive by far among the big cap MLP names. Investors were disappointed with their Q1 results but as I discussed in this post the future looks bright for ETP. As for KMP, it is a better value than it seems on the surface. Investors can purchase the different share class of KMP, listed under symbol KMR, which trades at a 12% discount to KMP and represents the exact same economic interest as KMP. The difference is that an investor received shares instead of cash distributions and a 1099 instead of a K-1 tax form. Investing in KMR gives the investor a yield of 6.94% which puts it above the historical average for KMP.

In summary the recent correction in the MLP space was minor based on historical metrics. The sector is now trading at a slight discount in terms of spreads to the 10 year treasury but still at a premium based on historical yields. Cheaper but not cheap is how I would summarize it. In the continued low rate environment we are in the sector seems to offering slight but nor overly compelling value. However, there are some individual MLP names that seem to be offering good value at current prices, specifically KMR and ETP.