Master Limited Partnerships (“MLPs”) returned -4.14% during the month of October compared to +2.33% for the S&P 500. October was a difficult month for MLPs. The AMZ fell 9% over a 14-day period mid-month following a couple surprise distribution announcements and the launch of a new $800mm IPO from international supermajor BP p.l.c. During this sell-off investor sentiment reached a 2017 low, in our view, as crude oil prices made steady gains and added insult to injury to investors that had endured downside crude oil price correlation only to sit out during the initial price recovery. Fortunately, the AMZ recovered somewhat into month end (+4% from 10/25 to 10/31) and third quarter earnings announcements began on a fairly positive note.
Surprise Distribution Announcements from EPD and GEL
After market close on October 12th, Genesis Energy, L.P. (NYSE: GEL) cut its distribution 31% in order to de-lever and avoid issuing equity to fund growth. This wasn’t all that surprising to us, but it took many investors by surprise as the majority of distribution cuts were thought to have already occurred during the depth of the 2015/2016 commodity price rout.
Perhaps more impactful to investor sentiment, however, was the surprise distribution growth reduction by Enterprise Products Partners L.P. (NYSE: EPD), the consensus standard-bearer of the MLP world. For years EPD had increased its distribution by the same amount every quarter, building up coverage in good times so it could maintain ratable increases through market cycles. No one expected this to change. Yet after market close on October 12th, the same day as the GEL distribution cut, EPD announced that it would be cutting its quarterly distribution increase in half in order to retain more cash and issue less expensive equity in this market. Many applauded the focus on cost and availability of growth capital, but others feared widespread distribution growth reductions and questioned how that might impact near-term performance—i.e., if the value proposition for MLPs is “yield + growth,” what happens if the latter is reduced across the board? Although we were caught off guard by the announcement, we trust EPD and its seasoned management team and believe its industry-leading backlog of growth projects can now be financed more effectively and generate even more distributable cash flow for each unitholder.
Investors “Make Room” for BP’s $800 million midstream MLP IPO
In our most recent quarterly commentary we discussed how, at times, we believe “that the sheer volume of new equity issued by companies can overwhelm investor demand, creating temporary technical pressure on midstream equities.” In our view, this was on full display during the month of October.
On October 16th BP Midstream Partners LP (NYSE: BPMP) launched an $800 million midstream MLP IPO that ultimately priced below the offering range on October 26th. During this 10-day marketing period, as dedicated MLP funds and others attempted to raise money for the IPO, open-end MLP mutual funds experienced net outflows of at least $40 million (by our estimates). The supply-demand mismatch is hard to ignore – $800 million of new supply from BPMP with negative
$40 million of new money for dedicated MLP funds. Therefore, to the extent dedicated MLP funds wanted to participate in the IPO, they would have had to sell existing MLP positions to “make room” for BPMP. As you might expect, the AMZ was down by as much as 7% during this period, even as crude oil prices increased by another 2%. As mentioned already above, as soon as the transaction priced and investors stopped “making room,” the market returned almost 4% into month end.
Third Quarter Earnings Off to a Solid Start
While the bulk of third quarter earnings will be reported during November, a handful of midstream MLPs reported at the end of October. Of the CCC holdings that reported in October, top-tier holding MPLX LP (NYSE: MPLX) stood out with a 7% beat to consensus EBITDA estimates that contributed to 5% outperformance in the final few days of the quarter. Most others reported in-line quarters or modestly beat estimates. Importantly, the recent hurricanes appear to have been less impactful than anticipated and production volumes are starting to show up in key growth regions such as the Permian, STACK/SCOOP, and Marcellus/Utica. November earnings announcements appear to be similar as management commentary supports a positive fundamental outlook into the fourth quarter of 2017 and throughout 2018.
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