MLP Round Up - The over-discounted DC Threat - 1Q11 Round Up
Comment of the Day

June 08 2011

Commentary by Eoin Treacy

MLP Round Up - The over-discounted DC Threat - 1Q11 Round Up

Thanks to a subscriber for this highly informative report by Paul Sankey and Silvio Micheloto for Deutsche Bank. Here is an important section:
Although potentially a disaster for MLP valuation, we don't see it happening
In May, the National Association of Publicly Traded Partnerships (NAPTP) highlighted a Treasury proposal to tax pass-through entities (like S Corps and MLPs) with gross revenues exceeding $50m at the corporate rate. This proposal prompted a broad selloff in MLPs as it would eliminate the tax advantages of the MLP structure, a development from prior legislation regarding partnerships and the issue of "carried interest". However the issue seems to have lost steam. Such a proposal will unlikely be passed by a Republican-controlled House, especially when Ways and Means Committee Chairman Dave Crump (R-MI) has stated it's "not something I'd be inclined to consider." And while Finance Committee Chairman Max Baucus (D-MT) said, "We're going to maybe have to look at pass throughs, say they've got to be treated as corporations if they earn above a certain income. It's one possibility," that would be in the realm of tax reform that is very difficult to envisage moving forward before 2013. Simply, with 2012 elections, nobody wants to stir the wasp's nest of changing the tax status of such a widely held retail investment product. Indeed, Baucus indicated that pipeline MLPs may be exempted. And in the past, when MLPs were targeted by Democrats for taxation, most of the talk has focused on financial partnerships and PE funds and explicitly exempted energy-related partnerships. And even then, with a Democrat controlled House and Senate, the proposed legislation on financial partnerships fell short; the split in Washington, between D Senate, R House, and Tea Party, makes major moves such as this highly unlikely pre-election, in our view.

Eoin Treacy's view This chart of the S&P/TSX Income Trust Index illustrates how affected the Canadian income trust sector was by the changes to their tax treatment announced in 2006. A similar change to how Master Limited Partnerships are assessed for tax purposes would presumably have a corresponding impact. However, I agree with the above report that this is an unlikely proposition in the current pre-election environment.

The MLP sector offers some of the more attractive yields on offer anywhere. Over the last two years, the better performers have been concentrated in the pipeline and shipping sectors which has resulted in investors benefitting from attractive, reliable yields and capital appreciation. However, on clicking through a number of such instruments, technical deterioration is becoming an increasingly common characteristic, particularly for previously highly consistent uptrends. This is a warning at a minimum.

The Alerian MLP Index has rallied impressively over the last two years. However, it has lost momentum and pulled back sharply over the last month. It is currently testing the area of the 200-day MA but will need to find support in this area if the medium-term uptrend is to continue to be given the benefit of the doubt.

Energy Transfer Partners is representative of instruments which have lost uptrend consistency and sustained moves below their 200-day MAs. The results of this Chart Library High/Low Filter indicate that of 45 MLPs included, 12 are making at least new 3-month lows and none are making new highs.

Teekay LNG Partners is one of only a few companies leveraged to the growth of LNG transportation. However, while it yields 7.21% and has a steady record of increasing its payout, the uptrend has lost some of its uptrend consistency. It needs to sustain back above $37 and the 200-day MA to indicate a return to medium-term demand dominance.

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