67 WALL STREET, New York - November 26, 2012 - The Wall Street Transcript has just published its Oil and Gas Investing Forecast Report offering a timely review of the sector to serious investors and industry executives. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.
Topics covered: Oil and Gas Investing
Companies include: Enterprise Product Partners, Williams Partners, Boardwalk Pipeline Partners and many others.
In the following excerpt from the Oil and Gas Investing Forecast Report, an expert asset manager discusses the outlook for the MLP sector for investors:
TWST: What makes you sell an MLP, and how often do you turn over your holdings?
Mr. Kessens: Relative value is the primary reason that we would sell a security, given our long-term approach. We try to remain almost fully invested. Our turnover is generally relatively low, anywhere between 15% and 25%.
TWST: How do you manage risk in your funds?
Mr. Kessens: We view risk, as I mentioned, as the potential for a permanent loss of capital. In our investment process, we perform a deep analysis of the firm's assets, management team and cash flow, and we believe the companies with the more strategic assets, the stronger management teams and more stable cash flow carry lower risks. As we manage the portfolio, we emphasize more of these top-tier names relative to other companies that may have a smaller asset footprint, merely adequate management and/or carry a high yield credit rating. We also have an investment committee structure, where any one member vote can result in the sale of a portfolio name versus the equivalent of all members vote required to buy. So it's hard to get in, easy to get out. These two risk-management tools have served us extremely well over the past decade.
TWST: What are some of the things investors should be careful about when investing in MLPs?
Mr. Kessens: I think it's a common belief that all MLPs have similar risks. That's a myth that if believed can potentially cause an investor a great deal of harm. Let's take a step back and really understand how each subsector generates its revenue.
Long-haul pipeline MLPs and pipeline companies derive their cash flows primarily from long-term fee-based contracts. Liquids pipelines - which are those transporting gasoline, diesel and crude oil - earn a fee per unit of throughput. And natural gas pipelines, they simply earn a fee, whether or not gas actually flows. This contract structure lends itself to stable, predictable cash flows. It's no surprise then that this cash flow stability translates into lower stock price volatility as measured by downside deviation and beta.
Gathering-and-processing MLPs and upstream MLPs, including both E&P and coal, earn a profit by selling a commodity whose underlying price varies virtually by the minute. This results in more uncertain cash flows and consequently greater stock price volatility. These companies attempt to hedge the commodity price over the short-to-medium term on a portion of their production, but they still remain subject to basis risk and illiquid forward product markets, and then at some point their hedges must roll.
Furthermore, pipeline companies tend to have larger, more strategic asset footprints. Combined with their cash flow stability, they garner investment-grade ratings providing greater access to credit markets and lower debt costs. Upstream and gathering and processing companies do not share the same benefit, encountering higher debt costs and require healthy capital markets to fund new projects.
You really don't need to look any further than the financial crisis in 2008 to understand the nature of risk between pipelines and commodity-sensitive MLPs. Multiple upstream and processing companies reduced their distributions, while only one long-haul pipeline MLP did. So I just urge investors to think about what type of companies they want in their infrastructure allocation.
For more of this interview and many others visit the Wall Street Transcript - a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs, portfolio managers and research analysts. This special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.