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By Josh Peters, CFA | 04-03-2014 02:00 PM

These Income Generators Are Losing Energy

It's a mistake to assume MLPs will continuously increase their distributions, says DividendInvestor editor Josh Peters, who discusses why he recently sold several names.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Midstream energy companies have been very much in the news recently. I'm here today with Josh Peters; he is editor of Morningstar DividendInvestor. He has recently made some moves in the master limited partnership space in its portfolio. We're going to talk about what he sold, why, and how investors should think about this space?

Josh, thanks for joining me today.

Josh Peters: Good to be here, Jeremy.

Glaser: Let's talk a little bit about why this has been in the news so much recently. Why have MLPs, in particular, been under such intense focus?

Peters: They're tremendous vehicles for income in an environment where interest rates are pretty low and other types of stocks, in general, are not offering relatively rich yields. If you go into MLPs, it's very common to find yields of 5%, 6%, 7%, or 8% in some cases, but at the same time you don't want to just take those yields for granted. And I think that it's a mistake to assume that just because an MLP is operating pipelines or storage terminals, assets that you think of as having very long useful lives and throwing off a lot of cash, that the distribution is going to be safe and just grow like clockwork.

One of the most notable events in this space here recently, which we've discussed before, was the blowup, and I think that's the right word--blowup--of Boardwalk Pipeline Partners, not too long ago. That was the type of event that should certainly make MLP investors go back to their holdings, go back to those names that they're interested in and scrutinize the asset quality as well as the financial strength of the partnerships that they own.

Glaser: When you went back and looked at your portfolio, what did you find? Why did you decide to make some moves?

Peters:  There were basically two names that I sold out of, though one of them has two securities associated with it. The first was Energy Transfer Equity, symbol ETE, which was one of the best-performing MLPs last year, with really an outstanding total return. Over time the Energy Transfer family has become more complicated. For a while, it looked like the partnership was starting to simplify itself and consolidate some of the intertwining operations among its various subsidiary partnerships: Energy Transfer Partners, Sunoco Logistics Partners, and Regency Energy. This kind of proliferation of partnerships here makes things kind of complicated.

And they're in the process of hopefully receiving full approval to add liquefied natural gas export capacity, which is a development that promises to provide a lot of steady cash flow for them in the future if the projects are executed successfully and they start up in kind of that 2020 time frame. And it's definitely a growth name. Yielding less than 3%, you're expecting lots and lots of growth from Energy Transfer Equity. And as a general partner, you hope that the incentive arrangements it has with these subsidiary partnerships will allow it to provide that growth.

But I wasn't real enthused by the valuation as the units really skyrocketed in value. Once the price crossed a point where it no longer yielded even as much as 3%, I became inclined to sell. But this is also an organization that relative to some of the other partnerships is known as being very aggressive. As an acquirer, it's very aggressive in terms of its organizational complexity and it's very aggressive in terms of distribution policy, frequently paying out a little bit more cash than the partnerships actually generate from their operations.

I didn't feel like that was the best position to be in. The combination of a pretty fair to full type of valuation--even considering all that growth--as well as the complexity and the aggressiveness of that business, I felt like it was time to let that go.

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