It's looking as if 2016 will be another tough year for energy companies. The most recent comments from management teams in the space suggest that we won't see a price recovery for a couple of more quarters and the entire industry probably won't pick back up again until 2017.
With that in mind, there are some companies to definitely avoid in 2016. Two companies that really stick out also happen to be master limited partnerships: LINN Energy (NASDAQOTH:LINEQ) and Williams Partners (NYSE:WPZ). Let's take a quick look at why these companies are struggling now and could see their prospects get even worse this coming year.
A year ago, an investment in Williams looked like a pretty smart one. The company had a huge backlog of projects that would lead to strong payment growth for the next five to 10 years, it was mostly serving natural gas producers with a concentration in the Marcellus shale area that desperately needs more infrastructure, and it was looking as if Williams Companies (NYSE:WMB) was going to make a move similar to Kinder Morgan, where the general partner would buy out the subsidiary partnership.
Fast-forward a year later, and the situation looks a lot different. Williams Companies went though a long and well-publicized buyout discussion with Energy Transfer Equity, natural gas prices have seen a decline similar to oil's, and all of a sudden the company looked in the mirror to find that it had a bloated balance sheet.
To make matters worse, Williams Companies just had its credit rating downgraded to "junk" status. That means new debt will come with higher interest rates, which also means many of those proposed projects won't be as economical as they had been previously. Furthermore, the share-price decline also means that it's prohibitively expensive to raise cash through an equity sale.
Then there's the coup de grace. Chesapeake Energy, one of Williams' clients, represents about 20% of its revenue stream. Chesapeake is dealing with its own debt and solvency issues, and if the company were to run into any trouble, it could result in contract renegotiations with Williams that won't be too promising.
All of these things together suggest that Williams is headed for some kind of distribution cut in 2016 unless something drastic happens in the energy market soon. With most oil companies now saying that 2016 will be a repeat performance of 2015, chances of seeing things change for the better are looking pretty slim.
I'll admit that I got lulled into thinking that LINN Energy would have the legs to survive the downturn in oil and gas prices. As an oil and gas producer that's completely exposed to the ups and downs of commodity prices, the company looked to smooth out that exposure with a robust portfolio of hedges and futures contracts that would ensure a certain level of cash flow stability.
Problem is, this kind of strategy isn't as effective when you have a long, sustained decline in oil prices of the sort we've seen lately. That's why today the company's stock is trading down more than 95% since oil prices started their downward spiral.
In hindsight, there were some things the company could have done to prevent such a disastrous decline. One thing that made the company's cash situation so dire is that management pushed a distribution policy that either left the company with no cash at the end of the quarter or, even worse, was more than what it made. This overly ambitious payout policy and its affection for making big deals left it with a sizable debt load that today simply can't be supported at today's prices.
LINN has been able to pay off some of this debt with some timely purchases, but it's still sitting on $10 billion in debt, an oil price that barely makes a return, and a suspended distribution that pretty much annuls the point of owning a partnership in the first place. LINN's share price might make some think things can't get any worse, but with that much debt overhang, the truth is that it can get worse.
What a Fool believes
There are a few opportunities worth considering in the master limited partnership space for 2016, but LINN Energy and Williams Partners are the investments you're looking for. Their high debt levels and lack of funding options to keep steady and growing cash coming in the door mean that neither is looking too healthy right now. Don't let those cheap stock prices and Williams' double-digit distribution yield trick you into thinking you're getting in on the ground floor -- there's a real chance things could get much worse for these two MLPs.