It’s been since May that I updated my table on MLP valuation. With the recent volatility in the market and the month of August coming to an end it is a good time to take a look at MLP valuation. Lets jump right in.
As I’ve done before, I updated my top 5 MLP table which also includes the MLP index, AMZ. I like to use both relative and absolute value metrics for any investments and I think the two best are dividend yield and the spread to the 10yr treasury note. Here is the updated table.
MLPs, the AMZ, are trading at a yield of 6.5% and a spread of 4.31%. In relation to their historical trading ranges, MLPs are trading at a lower dividend yield than average but way above their historical spread to treasuries. And here is lies the dilemma when looking at MLP valuation in today’s market. Usually, especially at the extremes, these two metrics move together. In other words, when spreads indicate the MLPs are cheap then the dividend yield is also signaling the same thing. This was definitely the case in the 2008 crises which was the extreme of extremes for MLP history. But this time is different, or so it seems. The question is whether the dividend yield is more correct or the spread to treasuries. Hard to tell, there are many many factors involved. For example, the MLP sector is much bigger, more stable, and more mature than it was 20 years ago. This alone would indicate that the sector would and should trade at a lower dividend yield than in the past. Personally, I lean toward the spread to treasuries as being the better indicator, especially short term, of value which indicates to me the sector is undervalued. However, even better is to focus on individual MLP names which I think is the best way to invest in the sector as I’ve discussed here and here.
As far as the big 5 MLPs are concerned, there is quite a difference in valuations. The lowest valued relative to its history is ETP. It is the only MLP trading at a discount to its historical yield and spread. KMP would be next on the list, trading at only a slight premium to its historical yield. And even better you can increase the yield on KMP by buying the other share class, KMR, at a 14% discount to KMP. At the other end of the spectrum you have EPD and WPZ both of which are trading at good premiums to historical yields. However, in both these companies investors should consider the individual factors that are driving these valuations. For example, EPD is one of the few MLPs without a general partner so its cost of capital is significantly lower than other MLPs. In the WPZ case they have an E&P business that will be spun off later in the year which is impacting valuation. These details matter a lot. Personally, I like KMP and EPD at these levels.
In summary, while MLPs have had quite a ride during the recent market volatility there is good value in the sector. With continues volatility there may be even better buying opportunities coming to a quote screen near you.