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Enterprise Products Partners L.P. Message Board

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  • arbtrdr arbtrdr Jan 6, 2010 5:44 PM Flag

    MLPs are now overvalued


    You said 300bps over the TBill rate is a historical range and I heartily agree. Since the 10yr TBill is selling at 3.82% the best investment grade MLPs should yield in the area of 6.75 to 7%. That is exactly where EPD is selling so it is fairly valued using interest rates as an analysis.

    The drop due to the secondary is a continuing opportunity as it raises the yield to closer to 7%.

    What many investors to not understand is the MLPs must py out most of the DCF to unitholders. This requires them to issue units and debt (about a 50/50 mix) to construct or buy new assets. If the new assets yield more than the 7% distribution rate or the approximate 7% bond rate the issuance of new debt and equity is NOT dilutive and if fact is the only way for a MLP to expand significantly. Since most of EPDs assets pay them in the 15% area the money used properly will be accretive and provide for additional distribution increases in the future.

    Going forward one simply needs to look at the distribution increases going forward that should be in the .01 to .0125 area for the next 4 quarters given the accretive nature of the Teppco merger and you get a Q410 distribution of about $2.40 in round numbers. Given a 6.75 to 7% yield this gives a unit price in the $34 to $6 range.

    If interest rates go up another 1% on the 10 year TBill and the historical correlation of .65 holds EPD will need to yield about 7.25 - 7.50%. This suggests a price of $32 to $34 using strictly a math equation.

    Personally I feel that EPD will increase theri distribution in the .0125 to .015 area and exit 2010 with a $2.45 distribution rate. Would guess this supports the current unit price plus a couple of $$.

    A flattening of the yield curve is not a big problem unless it inverts. The good news is MLPs are much more of a mainstream investment than even 2 or 3 years ago and the buying is from mostly retail customers. no indication of hedge funds screwing things up.

    A question, why do you say the more units creates more risk? Seems to people I talked to that a higher debt ratio makes for more leverage and that is more risk. More equity lowers the leverage and thus the risk ratio. This comment is from RBC Dain - not me.


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    • While they have increased distributions this past year, I don't think we can expect this will go on indefinitely without some unexpected interuption/disappointment and it would most likely occur in a rising rate environment. There doesn't appear to be much margin for error and I think you are underestimating the upside risk in long/medium/short rates. We are always just one Treasury auction away from a bad outcome. I am old enough to remember much higher rates. You need to guard against
      complacentcy and understimating the upside potential in Treasury rates. Like I said, people thought mortgages were safe because they thought house prices would only go up. What would happen to the unit price if T-Bonds go to 6, 7, or 8 percent?

      • 1 Reply to dinkdestroyer
      • dink,

        While it is true that MLPs are being bombarded by yield chasers I would submit that one should deal with their yield to cost. Then evaluate the distribution growth possibilities for the long run.

        I do disagree with you regarding distribution potential. We just went thru the worst year of business in our lifetimes and all of the major MLPs maintained and grew their distributions.

        Citi reports an expectation for a 6% increase in NG usage in 2010 because the business picture will be brighter. That will translate into higher distributions.

        MLPs are a special asset class because they are not correlated to the 10 year bond like reits which are absolutely correlated.

        I would expect reits to take a body blow the moment rates are finally raised. I do not expect the same of MLPs.

        TBonds are not going to those levels anytime soon but you can find plenty of analysis showing that MLPs did not negative correlate to higher interest rates.

        If MLPs are raising their distributions then you are in a sense keeping up with higher rates by receipt of higher distribution yields. MLPs are the closest thing to variable rate securities.

        Most importantly, you mentioned MLPs in the same sentence with garbage mortgage paper. MLPs have real assets and real business models.... as I have said for many many years that paper is just paper and boy did we find out that some of that stuff was better used to wipe our rear ends.

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