Last Wednesday, the S&P 500 was teetering on support at 2050. By Friday, it was back to 2100. Today, we’re right back in the middle (but things are starting to get heavy again this afternoon).
These are the types of random gyrations that can lead to an analyst or advisor spending all day watching his quote machine and the charts, worrying about whether all this volatility is going to end with a substantial decline that could hurt his clients’ portfolios.
I’ve even found myself getting caught “watching the tape” too closely at times and I’m sure you’ve done the same.
But, we’ve got to avoid this “analysis paralysis” if we all want to seize opportunities in the markets and be positioned to start 2016 strong, and the key to doing that is to:
1. Step back from the noise and stay focused on macro trends.
2. Look past short term influences to find attractive risk/reward set ups across markets that should help clients outperform once all the volatility subsides.
It’s how you turn markets like this into an opportunity for yourself and your clients, and by doing so strengthen that advisor/client relationship.
And, we’re looking to do just that with MLPs, which have fallen substantially over the past week and now offer unbelievable yields relative to where bond yields are.
To be clear, we’re not calling a “bottom” in energy broadly as that is going to be very difficult, given the conflicting influences of supply/demand, OPEC, speculators, ETF holdings, etc.
Instead we are focusing on trying to find some value in high yielding MLPs with three specific attributes that we think make them attractive over the medium and longer term for income hungry investors. In order to be attractive to us, the MLPs must:
1. Own The “Right” Energy Assets
2. Trade at a compelling valuation
3. Have an Experienced Management Team
If an MLP meets these three industry conditions, we believe there is a strong argument for a favorable risk-reward buying opportunity over the medium/longer term.
And, this is a prime example of our broad investment strategy which is simply:
Watch macro indicators to identify tactical opportunities across asset classes that can help our subscribers outperform the market and their competition.
We don’t call tops and bottoms, as we’ve learned over the years that’s a fool’s errand. Instead, we focus on catching the big trend changes that can offer months of outperformance.
So far, we’ve done well in our 3+ years in business, which is one reason our retention rate is still over 90%.
And, our subscribers have told us how our focus on medium term, tactical opportunities have helped them outperform for clients and grow their books of business.
In three years of doing this, the absolute best feedback I’ve ever received was when a client (an FA from a wire house firm based in Florida) called me late last year and said our Report helped him land a 25 Million dollar client!
Obviously that’s an extreme positive case, but the bottom line is our job is to watch all asset classes each and every day so we can do two things for our subscribers:
1. Get the overall direction of the market “Right’ so they can have the appropriate broad allocation for clients and
2. Do the hours of research needed to identify attractive risk/reward set ups across any and all asset classes: Stocks, Bonds, Currencies, and Commodities.
This week we are focused on MLPs and think there is an opportunity for longer and medium term investors – but selection is important, because not all MLPs will fare well in this environment, and some are an outright value trap.
Below we’ve included an excerpt from this week’s Sevens Report that describes the criteria we are using to select MLPs.
MLP Thoughts & Selection Criteria (Sevens Report Excerpt)
The carnage that’s been wrought upon the MLP space the last few trading days is simply historic.
Tuesday alone, AMLP (the biggest MLP ETF) dropped 7% and many MLPs are down well over 15% in just a few days.
The last time I saw an income-oriented sector get obliterated like this (with the obvious exception of the financial crisis) was in 2005 when the Canadian government changed the tax laws to eliminate the tax advantages of unit trusts listed in Canada, in what became known as the “Halloween Massacre” of 2005 (they announced the change October 31).
Kinder Morgan (KMI) now has assumed the leadership role in the MLP decline, as early last week KMI implied it may potentially use free cash next year to pay down debt or fund projects, and floated the “that which shall not be named” idea of either 1) Not increasing partner payouts or 2) Even reducing them. Indeed, yesterday KMI announced a large reduction in payout as it reduced its quarterly divided by more than 74%.
That action was already priced into markets and MLPs were bouncing with oil this morning. But, the bigger point here is that KMI is not some small, undercapitalized MLP, and between the rising concern about the sanctity of MLP dividends and oil collapsing (again) the MLP space has been in freefall.
Despite these declines, though, MLPs are still not historically cheap.
The main valuation metric for MLPs is EV/EBITDA (Enterprise Value over EBITDA) and research we read earlier this week stated that a wide basket of MLPs hit their lowest EV/EBITDA multiple at 8.8 back in ’09.
Currently, a similar MLP basket has an EV/EBITDA multiple of 11.5, so that’s much more in the middle of the 8.8—13.8 multi-year range (the 13.8 high came in ’14).
So, while deeply oversold, valuation metrics are not screaming “buy” right now on the broad MLP sector, and given the very real proposition of more distribution cuts, we are not advocating MLP ETFs right now.
That said, there is “panic in the streets” in this sector, and we always want to try and buy when there is “panic in the streets.”
So, while we would not advocate blindingly throwing money into the space because valuations are not historically cheap and the prospect of distribution cuts are real at weaker MLPs, there are opportunities in specific names.
How to Pick an MLP (Two Criteria to Use)
We’re going to be looking for MLPs that:
1) Have a good EV/EBITDA valuation (below 14x and the closer to 10X the better)
2) Generate the vast majority of revenue from fee-based projects, which insulates them from commodity price risk, for the most part.
Normally, we do not suggest single stocks to our subscribers and instead tend to stay with the ETFs. But, in this instance, because of the level of risk regarding dividend suspensions, we think that being more targeted makes sense.
So, we have already proposed two specific MLPs that meet our criteria.
MLP #1: Blue Chip Standout: The first was called a “Blue Chip Standout” in the MLP space by a JP Morgan analyst and despite having ample cash to cover distributions, an investment grade bond rating and a diversified, fee based business, it’s still down over 4% since last week and is yielding 6.5% as of this writing.
MLP #2: Double Digit Yield That’s Worth the Risk: The second is a bit riskier but offers more reward. It’s a natural gas liquids infrastructure ETF that is 1) Well capitalized and 2) Is in the ongoing process of switching to a large majority fee based structure.
As a result of this transition and the recent sell off, this company is now trading at a compelling valuation, below 10X EV/EBITDA. And, it’s yielding over 11% even with this morning’s rally, and given the fundamentals we think this is well worth the risk.
Our goal is to provide our subscribers with 5 MLPs to consider for clients (and themselves) by the end of the week, so we will be releasing 3 more between now and Friday.
In the very near term, MLPs trade with crude, so there’s likely more volatility ahead. But looking beyond the very short term, we do believe there are select tactical opportunities to be seized in this sector amidst all this carnage.
This could be a generational opportunity to buy high quality MLPs with near double digit yields.
Finally, there is a bullish wild card out there to consider.
We have read from several reputable sources lately that the idea of lifting the ban on US oil exports is gaining traction in Congress. We’ve been talking about this for nearly a year since a small rule change last year allowed the exporting of minimally refined oil products (condensate).
But, it seems like some momentum is building behind actually doing something, and that was further reinforced when two months ago the Department of Commerce approved exporting oil to Mexico – another small step towards the total repeal of the export ban put in place 40 years ago. There are some analysts that think the ban could be lifted as early as this month as part of a broader government funding agreement.
Again this isn’t a key tenant of our general thesis, but it is a potential wild card positive lurking out there.
The Sevens Report doesn’t just provide macro analysis – every day at 7 AM, in addition to that independent macro analysis we also identify specific ETFs and stocks that we think can help tactical investors outperform – and we monitor those picks and provide constant updates.
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