Blackstone Group (BX) and the Canadian Pension Plan Investment Board have more in common than the need to put billions of dollars to work. Both have recently channelled money into energy infrastructure assets.
It’s part of a resurgence of interest among private equity and pension managers in so-called master limited partnerships, companies that own pipelines, oil tanks, or other energy-infrastructure assets. They are supposed to produce stable cash flows, rather than soaring and diving in line with the price of oil.
Other investors should take a look to see if they are missing out.
So who is the CPP, anyway? It’s a $370 billion asset manager that invests money collected via payroll taxes to fund pension payments later. It’s a little like Social Security, but different in that it’s allowed to invest in a range of assets.
Earlier this week, the board bought a 35% stake in an energy pipeline system owned and operated by Williams (WMB).
The private-equity firm Blackstone invested in Tallgrass Energy (TGE) and Targa Resources (TRGP) earlier this year. TransMontaigne Partners was taken private at the end of last year.
Companies such as these are in the oil patch, but they don’t face the same challenges as those that drill for crude, or refine it into gasoline.
Both upstream energy assets such as exploration and production and downstream businesses—think refining and chemical manufacturing—have significant commodity-price risk. That makes their earnings volatile. Businesses like that often don’t take on much debt.
Midstream assets, by contrast, are supposed to be dependent on the volume of products they handle, and not the price of crude or petrochemicals. That means midstream businesses can support more debt and generate regular income for yield-hungry investors.
The problem is that distributions from MLPs haven’t been stable. Cash distributions fell when oil prices dropped in 2014 and 2015, after OPEC raised output. Back then, U.S. oil production declined and domestic exploration activity cratered. The lack of activity turned the oil-pricing problem into a volume problem for MLPs.
And investors have a long memory. The Alerian MLP Infrastructure Index (.AMZ) dropped 63% from a high of 891 before the OPEC production announcement to a low of 327 in 2016. Today, the Index sits at 440, still 50% off its all-time high.
“The inflection is here,” says Jay Hatfield, portfolio manager of InfraCap MLP (AMZA/IV). “Distributions are growing 5% to 6% a year now. That means returns will be double digits even if valuation multiples do nothing. That’s attractive.” Hatfield recommends investors focus on larger MLPs or exchange-traded funds when investing in the sector.
Stifel analyst Selman Akyol agrees that bigger is better, saying “we continue to prefer our large cap coverage given simplified structures, diversified footprints, improved coverage ratios, better balance sheets and virtually zero external equity needs.”
MLPs now generate 1.4 times the cash they’re paying out, making the dividends less likely to be cut than in the past. Before the sector slid in 2015 and 2016, cash generated and payouts were more or less equal, Akyol said.
Williams, the Canadian pension plan’s partner in its pipeline investment, is one large-capitalization company that Akyol recommends. Williams has a market cap of $34 billion and operations from Texas to Ohio, as well as a pipeline from Washington state to the Colorado Rockies. Akyol has the stock on his list of select picks.
Akyol isn’t alone in favoring the company and the CPP deal. Credit Suisse analyst Spiro Dounis believes the partnership with CPP makes sense and makes MLPs look more attractive.
“Analysis suggests the Canadian Pension Plan Investment Board may have paid a 14 times [Ebidta] multiple for its financial stake” in the joint venture, he wrote. Williams stock trades for about 11 times estimated 2019 earnings before interest, taxes, depreciation, and amortization, meaning private money is willing to pay more for assets than today’s public-market investors, he said.
Dounis rates Williams stock at Outperform, with a price target of $33, 17% above Tuesday’s closing price of $28.08. Williams stock yields 5.4%.
If things are improving and the outlook bright for MLPs, what’s not to like? Some investors may not be over the losses from the middle of the decade.
Hatfield acknowledges the issue. “You can manage risk with position size,” he says, “If you are comfortable holding 5% of your portfolio in utilities, then do 2.5% in MLPs.”
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