Friday, July 12, 2013

Which of These MLPs is a bargain?

From The Motley Fool
By Sarfaraz A. Khan
Research Assistant: G. Yousuf
Includes Western Gas Partners (NYSE:WES), Enterprise Product Partners (NYSE:EPD) and Alerian MLP ETF (NYSEARCA:AMLP)
The midstream arm of Anadarko PetroleumWestern Gas Partners (NYSE: WES) and midstream energy firm Enterprise Products Partners (NYSE: EPD) have formed a joint venture for two natural gas liquid, or NGL, fraction trains. Both of these energy infrastructure firms will become bigger and better in the coming years on the back of the U.S. oil and gas boom. Although I am bullish on these two firms, Enterprise Products in particular has outperformed Western Gas and is one of the most lucrative midstream investments at the moment. 

The Houston based Western Gas has acquired a 25% stake in the joint venture while Enterprise owns the remaining 75%. The partnership will invest $120 million in 2013 as construction cost.
They have also announced another project for second cryogenic processing train at the Lancaster plant in DJ basin called 'Lancaster II'. Construction will begin this year while commercial operations will begin from early 2015. The project comes with a price tag of $165 million. Expected capacity of Lancaster II is 300 million cubic feet per day (MMcf/d) while output of 200 MMcf/d is guaranteed by Western Gas.
MLPs: Risks vs. Return
Both Western Gas and Enterprise Products are Master Limited Partnerships (MLPs); i.e. they have a different structure as compared to a listed company or a real estate investment trust. MLPs have tax benefits of a limited partnership and are generally higher yielding stocks that distribute nearly all of their cash between their unit-holders.
An average MLP generates a yield of around 6%. In fact, the $7 billion market cap Alerian MLP ETF (NYSEMKT: AMLP), a fund which represents the 25 leading U.S listed midstream MLPs, gives a yield of 5.8%. Analysts are expecting around 6% to 7% growth in annual distribution of MLPs. This could easily translate into a total return of around 12% to 14% in a year.
However, there are some risks as well, particularly those coming from changes in tax status structure and increasing interest rates. In short, if President Obama makes the proposed changes to the tax structure of MLPs, then they would lose their coveted tax advantage. However, I believe that such a move is akin to a major overhaul and there are very little chances of this happening in the short term.
Secondly, like most high yield investments, MLPs have typically underperformed during the period of rising interest rates. These corporate entities rely heavily on the capital markets to raise their funds – since they are allowed to keep a very small percentage of their cash with themselves. A rise in interest rates makes borrowing -- and investments in MLP -- relatively more expensive. Moreover, the greater the investors are concerned about an economy, the poorer the MLPs are going to perform at the stock market.
While in the current business environment, I believe that benefits of investing in most of the midstream MLPs outweigh the risks but investors would make better decisions if they are aware of any potential pitfalls. 
The leading MLP Fund
The U.S is now producing more oil and gas than ever before and this output will most certainly increase in the coming years. This will translate into more business for the midstream sector. Both Western Gas and Enterprise Products are well positioned to capitalize on this gain. Although I am bullish on both of them as well as the Alerian MLP ETF in the long run but Enterprise Products looks more lucrative now.
Enterprise Products is the biggest holding in Alerian MLP ETF with a total weight of 9.53% while Western Gas is the fourteenth largest with a weight of 2.85%. In the past six months, both of these companies have easily outperformed Alerian MLP ETF which has risen by 12%.
Although in the past few years, the number of MLPs have risen significantly which is a cause of concern for some of the investors but the overall trend is still bullish. Short interest in this sector is considerably low as compared to other sectors therefore, as MLPs continues to soar at the stock market, a short squeeze is highly unlikely.
Why Enterprise Products?
One thing which I like about Enterprise Products in particular is that, unlike most of its peers, it has no general partner. This translates into lower capital costs as it does not have to make any payments, such as incentive distribution rights, to the general partner. This also means that there is more cash left to be distributed among the unit holders. On the other hand, Western Gas, has Anadarko Petroleum as its general partner.
Second, in its most recent results, Enterprise Products has delivered a relatively better performance than Western Gas. In the first quarter Western Gas reported revenue growth of 2.3% to $229.75 million which translated into earnings of $0.31 per share. The company missedboth revenue and income estimates. On other hand Enterprise Products beat the earnings but missed the revenue estimates. It reported earnings of $0.73 per share from revenues of $11.38 billion.
Third, Enterprise plans to spend $7.5 billion in the coming years for expansion while it is eyeing greater exposure to shale gas, particularly at the Eagle Ford where it has invested billions. Earlier in May, Jim Cramer identified Enterprise Products as one of the “best of the best” MLPs out there that you can own.
Fourthly, Enterprise Products is considerably cheaper than Western Gas but the former has generated a higher return on equity (ROE). Enterprise Products' shares are trading at 21 times its full year profit estimates while it gives an ROE of 19.17%. On the other hand, Western Gas is trading 43 times its full year’s earnings estimates and has generated an ROE of just 6.88%.
Finally, Western Gas gives a yield of 3.3% while Enterprise Products gives 4.3% at current price levels. Therefore, although I recommend both firms, I believe that Enterprise Products is a bargain. 
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I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours of this publication. I wrote this article myself, and it expresses my own personal opinion. I have no business relationship with any company whose stock is mentioned in this article.