Low Interest Rates Could Mean Big Gains for MLPs in 2014

With stocks up 25%-30% this year to all-time highs, a significant rally next year could be asking for too much. Corporate profit margins are near all-time highs, suggesting that mean-reversion in this cyclical metric could be at hand. Importantly, the percentage of investors that are bearish is near historical lows, typically a robust contrarian indicator. Therefore, I see multiple scenarios in which common stocks trade sideways in the coming year. 

How likely is it for markets to rally again next year? 
Pundits have been surprised at the strong rally in stocks this year. Most agree that the reason for the spike in stocks is the Fed's continued quantitative easing, to the tune of $85 billion per month. The exact mechanisms by which this liquidity injection fundamentally supports the stock market is unclear. However, it has proven to be a strong factor in giving investors the courage to follow the bullish herd. 

If stocks begin to run out of steam, perhaps due to a continued lackluster economy, weak retail sales or a diminished margins, interest rates would remain ultra-low for an extended period. While low interest rates have fueled the market this year, will that be enough to prolong the party indefinitely? Due to high distribution yields, there's a scenario in which master limited partnerships, or MLPs, continue to grind higher long after stocks stall.

The search for yield could kick into high gear
This year there's plenty of evidence of investors reaching for yield and increased risk-taking behavior in asset classes like leveraged loans, sovereign debt, and high yield bonds. Yields on many common stocks have fallen dramatically as well. Yet, select MLPs still offer double digit yields that are increasingly attractive on a relative basis. For example, units of Natural Resource Partners (NYSE: NRP  ) are yielding 11%. Even if this company's financial metrics fail to improve next year, 11% is 2-4 times the yield of alternative investments.

Therefore, in an environment where investors recognize that stocks may not rally next year, an ever growing number will be hungry for yield. By the end of 2014, MLPs like Natural Resource Partners could be yielding far less than 11% as investors eagerly buy units. If the required hurdle rate (yield) to own Natural Resource Partners is 10%, 9%, 8%, or 7%, then the one year total return on a unit of would be 23%, 35%, 50% or 70%, respectively. These prospective outcomes are not as aggressive as one might think. If at the end of next year interest rates are still artificially low, a desperate search for yield could reasonably drive hurdle rates on MLP's significantly lower and unit prices higher.

Alliance Resource Partners remains very attractive as well 
Another MLP that I've liked for some time is Alliance Resource Partners (NASDAQ: ARLP  ) . Unlike most energy-related MLPs, Alliance is an actual producer of a commodity, namely thermal coal used in coal-fired power plants to generate electricity. Alliance has proven to be the premier coal producer in the U.S., vastly outperforming peers like Arch Coal (NYSE: ACI  ) , Peabody Energy (NYSE: BTU  ) , and Alpha Natural Resources (NYSE: ANR  ) , each down 35%-45% from 52-week highs. By comparison, Alliance is within 5% of its 52-week high. 

Interestingly, Arch, Peabody and Alpha have each staged impressive rallies from their respective 52-week lows, i.e. they were much lower at the beginning of 2013. However, the rally in coal stocks may be nearing an end as underlying coal prices have stopped moving up and utility stockpiles remain elevated. Further, this year several planned west coast and Gulf of Mexico port facility projects have been canceled or severely delayed. This will have a long-lasting negative impact on Powder River Basin coal pricing.    

Despite Alliance's strong relative outperformance, it still offers a juicy yield of 6.5% (based on a quarterly distribution growth rate of 2% in 2014). If the hurdle rate to own Alliance Resource Partners were to fall to 5%, still in the middle of the pack of MLP yields, the total one-year return would be 36%. I have to believe that a possible 36% return in 2014 would be a spectacular outcome. Importantly, an investment in Alliance is not a desperate stretch for yield as it has the best margins, lowest debt leverage, and strong earnings visibility for both 2014 and 2015. The company operates in the top coal basin in the country and has industry-low costs.

Final thoughts
In a scenario of ultra-low interest rates that last longer than expected, a natural progression from this year's melt up in stocks could be that high-yielding investments become significantly more sought after. As stocks possibly languish next year or even decline, investments with high current yields could still flourish. Both Natural Resource Partners and Alliance Resource Partners would greatly benefit from continued, and perhaps, accelerated yield compression in asset classes.  

Searching for yield? The Fool can help.
Dividend stocks can make you rich. It's as simple as that. While they don't garner the notoriety of high-flying growth stocks, they're also less likely to crash and burn. And over the long term, the compounding effect of the quarterly payouts, as well as their growth, adds up faster than most investors imagine. With this in mind, our analysts sat down to identify the absolute best of the best when it comes to rock-solid dividend stocks, drawing up a list in this free report of nine that fit the bill. To discover the identities of these companies before the rest of the market catches on, you can download this valuable free report by simply clicking here now.

Read/Post Comments (1) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 11, 2013, at 1:40 PM, dy2 wrote:

    Nice article.

    In a recent quarterly conf. call, ARLP said their internal data showed a closer balance of thermal coal inventory/demand than is generally believed. If so, and I believe it is so, any increased demand, whether from weather or otherwise, could have a stronger than expected impact, especially on NRP, which has some weaker than would be desired Cent. App. properties. The weather has certainly cooperated in early December.

    A longer term issue which I think is important, but which I believe ARLP has carefully avoided discussing, is the pending vast widening of the Panama Canal. This will enable much more efficient Post Panamax ships to carry bulk commodities, such as Coal and Petroleum (and refined products) to China, India, Korea, and Japan. This expansion began in 2005 and I think was part of ARLP's interest in the White Oak development. White Oak can ship coal down the Miss.R., to the Canal, and then to Asia. There is a limit to how much more Illinois basin coal can displace Cent. App. coal, although I don't think we're close to the limit yet, nor does ARLP.

    One further point on NRP. The hydraulic fracturing industry is beginning to use MUCH larger quantities of sand in their processes (See EOG, for example). NRP, in their recent several years purchases, have become a major player in this material. The increasing demand and price for sand should help NRP substantially.

    I think NRP will be weak this month (Dec.) because of tax loss selling, making this a good buying opportunity.

Add your comment.

DocumentId: 2761206, ~/Articles/ArticleHandler.aspx, 4/19/2014 8:58:28 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...