The whole point of an MLP is to spill cash. It's tempting to reach for yield, grabbing partnerships that ooze lots of cash. Be careful that your distribution is safe and sensible, though. Tight coverage and tiny distribution raises may keep the masses happy, but they bode poorly for the future. Look to the partnerships with wide coverage ratios, a disciplined approach and a solid pipeline of capital programs. They can be the gifts that keep on giving, putting dollars in your pocket for years to come.
Kinder Morgan Energy Partners (NYSE: KMP ) , Williams Partners (NYSE: WPZ ) and ONEOK Partners (NYSE: OKS ) have all had challenging years, with investors facing total returns ranging from a net loss at ONEOK to a meager 7% gain for Kinder Morgan.
In contrast, their peers had smash-mouth years, providing investors 20% to 50% total returns on the year.
Investors in these laggards need to ask themselves what's wrong and what needs to change to reverse these trends.
More is better
It sure is, but which more? More yield, or more coverage? The immediate impulse is to reach for yield. After all, what's better than more cash from your investments?
How about better assurances that you won't see a cut?
Compare the winners and losers in total return. All those winners have solid coverage ratios and most have conservative yields. Two of three losers are tight on coverage and deliver huge yields. It's not simply a coincidence. When faced with the potential for cuts, income investors vote with their feet, driving up yield.
Here's a look at the laggards and their challenges.
Kinder Morgan Partners' growth challenge
Coverage is running slightly low at 0.9, but is forecast to close the full year on target. It's a well-respected company that's surprisingly short on DCF and unit performance. Much of that is likely attributable to Hedgeye's high profile short attack.
There are other issues, though. Kinder Morgan is huge, making meaningful growth a challenge. It's tough to move the needle at Kinder's mass. Complicating the matter is the fact that KMP's incentive distribution rights are maxed out. For every incremental dollar of new growth, KMI, Kinder Morgan's general partner gets a 51% cut before the limited partners see a dime.
You're second in line for every penny of new cash flow. That cramps KMP's style. Growth ultimately drives total return, and KMP trails even its stable mate in that department. Sister MLP El Paso Pipeline Partners (NYSE: EPB ) projects 13% growth on the year versus KMP's 7%.
If you like Kinder's management, why not just buy EPB? KMP's a solid historical performer, but it's hard to ignore the current reality that KMP is playing second fiddle in its own band.
Williams Partners is behind the Eight Ball
A catastrophic fire at Williams Partners' Geismar olefin plant put the company in a serious bind that amplified already existing challenges. The company is heavily leveraged to natural gas in its pipeline, gathering and processing activity. Williams missed guidance back in Q2 of 2012 on the back of plunging NGL prices. Units have suffered ever since.
In light of multiple headwinds and deficient coverage, the market's lack of confidence is understandable. Yet, Williams has some interesting projects on slate. It helps that Williams Partners' GP, Williams Companies (NYSE: WMB ) , is actively committed to propping its limited partner up. The GP waived a large portion of its 2013 IDR payments to keep coverage at these bare-bone 0.9x levels, so distribution cuts seem unlikely.
A new drop down will occur early in 2014, and insurance proceeds kick in for Geismar going forward, so this quarter saw the worst of the Geismar-related losses. Guidance is for 9% incremental distribution growth in 2013, followed by tepid 6% gains in 2014 and 2015.
Given all the uncertainty and the high yield, this is probably a turnaround story only of interest to those with the fortitude to gut it out for that high yield.
ONEOK Partners also has a bad case of gas
ONEOK Partners is in the midst of an extensive capital plan centered on exploiting North America's new unconventional shale production. The shale revolution spawned expansion of the Gulf Coast's petrochemical facilities and ONEOK is building out its assets to supply feedstock for those plants.
Despite new volumes from those projects, crashing ethane prices threw a wrench into ONEOK's well-laid plans. Prices are so deflated that gathering plants aren't bothering to extract ethane. That dropped pipeline volumes, while weak pricing hit revenues on NGLs sold. Worse yet, weak Mont Belvieu-Conway spreads dried up ONEOK's traditional pricing arbitrage business between the two NGL hubs.
The best medicine is simply for customers to burn through that excess ethane inventory, stabilizing prices. Unfortunately, ONEOK doesn't see that happening until 2014. In fact, ONEOK expects price challenges in its Rocky Mountain Williston operations to extend into 2015. The market appears concerned.
Don't ignore capital gains in your income portfolio
Large dividends are nice, but the best dividend is a safe dividend. Identifying the challenges faced by laggards like these is critical. Williams Partners and ONEOK face headwinds from poor NGL and nat gas pricing, and Kinder Morgan Energy Partners units are laboring through a short attack. While none of the three seems destined for a cut, future growth seems likely to underperform the peer group. It's easy to focus on yield, but you could be leaving a lot on the table if you ignore growth potential when shopping for MLPs. Focus on total returns instead.
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