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Thursday, February 25, 2016

MLPs - What's Going On Here and How Might It Affect Marketers?

Source: Observations from the Executive Suite
By Jeff Kramer, Managing Director, NRC Realty & Capital Advisors

Since the beginning of 2016, MLP stock prices have been under pressure, and, as often happens, more than the overall stock market. Clearly, some of the extractive companies, like oil and gas production, or coal, will have to merge or go out of business. But what is going on with MLPs and their sponsors that are downstream players seemingly benefitting from low oil prices?

No doubt there is a huge factor of 'throwing out the baby with the bath water'. Stock market indexes like the Alerian MLP Index (AMZX) help create tradable securities that mimic the index, such as the Alerian MLP ETF (AMLP) and the J.P. Morgan Alerian ETN (AMJ), and thus have all types of MLPs under one portfolio. When the overall market gets hammered, fund managers often must sell all underlying securities, sometimes at any price. Many MLPs have relatively small market capitalizations making them illiquid, going up or down more than the general market.

But not all downstream MLPs are created equal. Some MLPs have more cyclical refining assets. Some MLPs have ethanol blending operations that utilize volatile RIN blending credits important to their profitability.

Retail margins have been fairly stable, but do vary considerably from quarter to quarter, which Wall Street has never liked. And many downstream MLPs have important wholesale margin dependence on branded fuel and typically benefit from the 1.0-1.25% discount for fast pay terms. $30 oil versus $100 oil reduces their gross margins by about 2c per gallon, and that is a big percentage bite out of a gross margin that may have been averaging 5c per gallon at $100 oil.

Despite already high yield distributions, MLPs have always been growth driven as part of their basic economic model and 'raison d'etre' for maintaining and increasing distributions. But lately that fact has come back to haunt them. Despite recent market setbacks, MLP enterprise multiples (enterprise value multiples are basically equity value plus long term debt divided by 'cash flow') typically remain higher than their corresponding sponsor companies or General Partners, which is important for the successful transfer or 'drop down' of assets. However, purchase multiples have risen so significantly in the last two years that there may no longer be assurance that acquisitions will be accretive to earnings of the respective entities. And, as some stock market analysts have pointed out, if economic growth slows and extraordinary capital expenditures such as EMV come along, dividend distributions may need to be cut or debt increased just to maintain dividends - not good.

MLPs were often sold for their high yields with 'widows and orphan' characteristics, but we are clearly seeing the other side. We may be in the middle of a huge shift from retail type MLP investor ownership to more institutional type ownership. This change may be how the Chinese are feeling as they shift from a huge export led industrial manufacturing economy to a more consumer oriented economy. Never easy, although creating some great bargains when the dust settles.

What does the MLP situation mean for strong, growing marketers in what has been, and likely will remain, a very healthy industry? It likely means some slowing in M & A activity, at least until MLP stock prices stabilize. It may also mean that the high end of purchase price multiples will be shaved, as supply and demand for companies comes into better balance. We have never seen the likes of the seller's market of the last two years. For many would be buyers who could not compete for recent acquisitions, this could be welcome news.