Over the past few weeks, the MLP sector has seen a sharp pullback in share prices. Immediate causes include concerns over interest rates and a ruling from the Federal Energy Regulatory Commission that may impact the fees certain operators are able to charge on pipelines.
Alerian MLP Total Return Index – Last 12 Months Source: Bloomberg
As a result, the valuation of MLPs is down to levels approaching early 2016 lows – when commodity prices were significantly lower and the ability of oil and gas producers to pay for their midstream commitments was in question.
Alerian MLP Total Return Index – EV / EBITDA Source: Bloomberg
By contrast, current industry fundamentals are improving. EBITDA is expected to grow at a rate of more than 12% over the coming years as volumes increase. Stronger earnings will put more companies in the position to internally finance projects rather than issuing new debt and equity. This earnings improvement would also help the sustainability and growth potential of dividend payouts.
Source: Bloomberg Consensus Expectations
We believe this represents a dislocation between fundamentals and valuations. Yields are attractive, and there is potential for capital appreciation should valuations revert toward historical norms. Risks relating to commodity price exposure, leverage, and regulation are ever present in the space. However, current valuations imply that those risks are now discounted more deeply than they have normally been in recent years.
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