These 2 Stocks Might Copy Kinder Morgan’s MLP Reversion

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Master limited partnerships (MLPs) are all the rage with energy firms and investors these days. The corporate structure is quite lucrative on both fronts — promising huge tax advantaged distributions to its owners. Add in the need for more energy logistics infrastructure due to America’ shale boom and it’s easy to see why MLPs have gotten so big over the last few years.

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Perhaps they’ve gotten too big.

The major news in MLP-land this week was midstream giant Kinder Morgan’s (KMI) decision to swallow its two MLP subsidiaries — Kinder Morgan Partners (KMP) and El Paso Pipeline Partners (EPB) — back into its mix. Essentially, KMI is turning its back on the structure it helped pioneer.

That raises a couple of questions: What other firms may be too big for the structure … and are MLPs doomed?

A Question Of Cash Flows for MLPs

For Kinder Morgan, the decision to end its MLP relationship — now called a reversion — came down to meaningful cash flow and distribution growth. The problem was that KMI and KMP required insane amounts of new projects and CAPEX spending in order to add enough assets to boost cash flows. Morningstar predicted that, for Kinder to increase its distribution by 5% to 6% per year, the firm would have to put nearly $4 billion to work every year on new projects.

And given its high cost of raising capital, that was a daunting task. Institutional investors for the most part don’t want MLP shares — due to regulations — and KMI’s size meant that adding new debt was expensive.

In the end, Kinder Morgan was growing its distribution, but not enough to satisfy analysts and investors. Under the new C-corp structure and KMI ticker, Kinder should be able to fund its growth better and ultimately meaningfully increase its distribution over the long haul.

So the question now is whether any other firms are looking into ditching the previous lucrative MLP structure for something different. The answer could be a resounding yes for a select group of larger partnerships.

Both Enterprise Products Partners (EPD) and Energy Transfer Partners (ETP) could be prime candidates for a reversion.

Cash flows at both MLPs are still growing, but the rates of increases to their distributions have slipped over the last few quarters. Like KMP, both EPD and ETP are monsters in the midstream and energy logistics world. Both feature miles & miles of pipelines, gathering systems and processing equipment, not to mention various terminals and barge assets. And like Kinder, it’ll take some big buys and spending for the duo to cause a meaningful jump in their cash flows.

For example, ETP and its related firms are worth nearly $50 billion in combined market cap. Given that size, buying a small 200-mile pipeline isn’t going to move the needle at Energy Transfer. That explains why ETP recently made a $15 billion bid for mid-sized natural gas processor Targa Resources (NGLS). But that deal fell through due to the rising price on NGLS shares and overall total cost to make it happen. Again, $15 billion is not chump change.

Enterprise Products is a similar boat with its $71 billion market cap, and it has been forced to expand in all matters of energy midstream infrastructure to keep itself going strong. Most of those deals have been multiple smaller buys.

Given just how large these two MLPs have become, analysts now predict that KMP’s decision could serve as a blueprint for a new wave of consolidation and reversions in the MLP sector. Goldman Sach’s estimates that this is just step one in a new wave of deals.

MLPs Not Going Away Just Yet

So, as an income investor, should you be worried about the death of MLPs as we know them?

The short answer is a big no. The tax structure is too lucrative to ignore, and an increasing number of firms are looking towards using it. In fact, we’ve grown from just 66 MLPs back in 2009 to more than 120 worth around $500 billion in market cap today. The problem is that some of the elder statesmen of the industry may be getting a tad bit fat.

Investors need to understand that, in order to get the biggest distribution from these things, thinking smaller may be a better option if you’re going to play MLPs. And that’s not to say that EPD and ETP aren’t great firms. They just may need to follow a similar path as Kinder Morgan in order to meaningful grow any larger.

That’s fine if you’re using the duo to bet on the strength of America’s energy industry … not so great if looking for high initial dividends. KMP and El Paso unit holders are actually going to take a significant haircut on their initial yield when the deal at Kinder takes place.

Reversions are just another thing to think about and add into your analysis when buying these larger MLPs.

As of this writing, Aaron Levitt was long KMI.

Aaron Levitt is an investment journalist living in Ohio. With nearly two decades of experience, his work appears in several high-profile publications in both print and on the web. Also likes a good Reuben sandwich. Follow his picks and pans on Twitter at @AaronLevitt.


Article printed from InvestorPlace Media, https://investorplace.com/2014/08/mlps-reversion-kmp-kmi-epd-etp/.

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