Master limited partnership (MLP) weakness appears overdone. The Alerian MLP Index has lost 9.3% in 2017 year to date, well behind the S&P 500 Index’s 17.5% return and even the energy sector’s 6.3% loss. More recent performance is particularly surprising given the 30% rally in WTI crude prices since June 21, 2017—the Alerian MLP Index has been flat over that roughly 4.5-month period, while the S&P 500 has returned 7%. In an environment where many investments look stretched, this is one that has lagged behind and could offer potentially more upside. Here we discuss several reasons the group has struggled and make the case that it may be due for a turnaround.
We see several reasons for MLPs’ recent underperformance, including:
Distribution cuts. Several MLPs have cut their distributions over the past three months, hurting those securities and the group on spillover concerns. These securities are generally held for their income so distribution cuts can be very damaging.
Slower growth. A number of MLPs have focused more on lowering their costs of capital and deploying their capital more efficiently, contributing to reduced growth expectations. That likely translates into slower distribution growth.
Capital allocation. Some investors are concerned that MLPs may have overinvested—or will overinvest—in pipeline expansions, introducing the risk of potentially costly debt or equity financings. Recent equity offerings have pressured the group.
Weak natural gas prices. While oil prices have rallied sharply since June, natural gas prices rose only 3%, weighing on MLPs, which transport both commodities.
Legislative risk. Some are worried that MLPs might lose their favored tax status as part of tax reform. After MLPs were left out of the House’s tax reform bill that was released last week, and considering that MLPs offer a small amount of potential tax revenue, we view this as very unlikely.