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Is Now the Time to Buy MLPs?

By Jay Yao - Mar 24, 2016 at 7:45AM

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Does Berkshire Hathaway's 26.53 million-share buy-in of Kinder Morgan make the midstream/MLP sector more attractive?

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MLPs haven't done well. Since the start of 2015, the Alerian MLP index has fallen 40%, and many individual MLPs have declined further than that, as various concerns weigh on the sector. With the news that Berkshire Hathaway (NYSE: BRK-B) bought 26.53 million shares of the former MLP Kinder Morgan (NYSE: KMI), however, there seems to be a light at the end of the tunnel. Are MLPs safe to dive into again? 

Not necessarily a Buffett purchase
Although Berkshire Hathaway bought into Kinder Morgan, Warren Buffett might not have been the one doing the buying. Because his portfolio is so large, Buffett typically makes purchases that number in the billions. The size of the Kinder Morgan transaction -- a 26.53 million-share stake worth $395.9 million -- falls well short of a billion and is more indicative that one of Buffett's lieutenants, Todd Combs or Ted Weschler, made the Kinder purchase instead. Because Buffett didn't make the purchase, Berkshire's buy-in isn't as bullish for the sector as it looks. 

Why MLPs have fallen
MLPs have fallen on hard times for two reasons: low energy prices and weak investor confidence. Low energy prices have made it difficult for producers such as Chesapeake Energy, which is leveraged and has high production costs, to remain profitable and to pay their bills. The lower resulting production has trimmed the volumes that pass through MLP pipelines and has lowered MLP EBITDA. Because many MLPs are leveraged, investors became afraid that some MLPs' net debt-to-EBITDA ratios were too high for comfort and that management of those MLPs needed to cut their dividends to reduce debt to the right size. 

When former MLP Kinder Morgan cut its dividend by 75% in December, those bearish investor doubts were confirmed and investors became afraid that other MLPs would cut their dividends, too. The resulting sell-off greatly damaged investor confidence in the sector and made affordable growth capital difficult to raise.

Not all MLPs are the same
In the low-energy-price environment, some MLPs and midstream companies are better than others. Conservatively run companies, such as Enterprise Products Partners (NYSE: EPD) which has a net debt-to-EBITDA ratio of under 4.5 and a 2015 dividend coverage of 1.3, aren't in danger of cutting their dividends. Neither is Holly Energy Partners (NYSE: HEP), which has a debt-to-EBITDA ratio of 4.3 and has increased its distribution every quarter for 45 consecutive quarters.  

Because they have modest debt loads and are in the right basins where production won't decline much, Enterprise Products Partners and Holly Energy Partners will do well no matter what. If crude and natural gas prices stay low, the two will pay steady dividends and offer some payout growth. If crude and natural gas prices rise, their dividends could grow even faster. 

Other MLPs and midstream companies aren't certain bets for the low-energy-price environment. Because Chesapeake Energy accounts for around 20% of Williams Companies' (NYSE: WMB) revenue and Chesapeake has been struggling of late, Williams Companies' dividend-raising prospects are not as great and the company will need energy prices to move higher to do well. 

Investor takeaway

Although Berkshire Hathaway's buy-in of Kinder Morgan doesn't make purchasing the weaker-tiered MLPs any safer, Berkshire's Kinder purchase does make the case of buying robust MLPs and midstream companies such as Enterprise Products Partners and Holly Energy Partners stronger. Both companies offer attractive yields, steady payout growth, and the potential for substantial capital appreciation if energy prices rebound. Both now also have a savvy investor, and a savvy investor's disciple, investing in their sector, too.

TMFJay22 has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway and Kinder Morgan. The Motley Fool has the following options: short June 2016 $12 puts on Kinder Morgan. The Motley Fool recommends Enterprise Products Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
$304.27 (0.00%) $0.01
The Williams Companies, Inc. Stock Quote
The Williams Companies, Inc.
$35.24 (2.74%) $0.94
Enterprise Products Partners L.P. Stock Quote
Enterprise Products Partners L.P.
$27.31 (1.30%) $0.35
Kinder Morgan, Inc. Stock Quote
Kinder Morgan, Inc.
$18.93 (1.94%) $0.36
Chesapeake Energy Corporation Stock Quote
Chesapeake Energy Corporation
Holly Energy Partners, L.P. Stock Quote
Holly Energy Partners, L.P.
$17.74 (2.48%) $0.43

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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