The two indices you might know best, The Dow Jones and the S&P 500, are just numbers. Despite understanding that fact, I still sometimes find myself looking at stocks and saying "I'll take another look at selling when the Dow hits X thousand." For me, Dow 17,000 served as something of a reminder that valuations have continued to march upward for the last five years. While the big indices, the Dow especially, do not necessarily show the 'big picture,' they can often serve as simple reminders to step back and look at one's watch list as a whole.
This article will look at an industry that has been increasingly important for retail investors over the past decade; pipeline master limited partnerships, or pipeline MLPs. Most of the big pipeline MLPs have gone up significantly over just the past couple years, and while this definitely is a secular growth industry, these partnerships' high valuations are enough to warrant caution right now.
Consider one of the very biggest pipeline MLPs, Enterprise Products Partners (NYSE: EPD ) . Despite having a market cap of over $70 billion, Enterprise has vaulted up by almost 50% since just the beginning of 2013. For its part, Enterprise has established itself as a best of breed pipeline for a few reasons: Simple ownership structure, a cushy distribution coverage ratio, and a great midstream position in the natural gas liquids market.
But look at this chart for a moment. Price to distributable cash flow, or price to DCF is now at a lofty 25 times. And while retail investors in pipeline MLPs usually invest for income, thanks to ever-rising unit price, Enterprise's yield has dropped to about 3.75%, which is now lower than most utility companies.
But what about the growth? Enterprise does not normally give forward DCF guidance, but results for the year show that the partnership is on-course for low double-digit DCF growth. That growth isn't bad, but at almost 25 times DCF, it really is best to be cautious.
This chart represents valuation for Plains All American (NYSE: PAA ) , and, as you can see, Plains' story is similar to that of Enterprise's. Price to DCF is a hair over 23 times. With a yield of 4.35%, Plains is also very utility-like. Over the last ten years, Plains has averaged distribution growth of 7.7%, and while that track record is certainly not bad, at 23 times DCF, Plains is fully valued at least.
General caution is warranted within the pipeline space, but there are still good values out there which an investor today should consider, not least because this industry is undoubtedly in a secular growth phase.
The midstream MLP in this chart is Williams Partners (NYSE: WPZ ) . Williams offers a much more reasonable valuation, with price to DCF still under 15 times and a generous yield of 6.8%. Even better, Williams expects to grow distributions at a rate similar to the other partnerships; about 7% per year until 2016. However, Williams is, admittedly, less established than are the other two partnerships mentioned, and its trailing twelve-month DCF coverage ratio is just below 1 times. Although Williams' strong asset base, which includes the Transco Pipeline, will probably allow the partnership to meet all its distribution promises in the future, some may see Williams as a 'trade down' in quality.
Don't be in a rush to jump into pipelines. Valuations have climbed steadily over the past few years, and most of the better partnerships are now fully valued at least. If you got into these names a couple years ago, great. If you didn't, then at some point in the future, there may come a better time to get into these names. Today is no time to be hasty.
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