Some Perspective For The Volatile Energy Sector & MLPs

2015 has been an interesting year with lots of volatility.  In particular, was the decline of energy sector stocks and MLPs.  Most of these have seen their prices plummet across the board, sending investors panicking towards the exit en masse. Time to put things into perspective for investors.

 

#1 Don’t Panic

First things first.  Don’t panic. Panicking does nothing for you – expect for helping you lose money fast!  Now, lets slow things down a bit.

 

What Is A MLP?

The acronym MLP has used a lot these days, and that’s an understatement!  It’s been mentioned all over the financial news, in blogs, etc.  For those of you who don’t know a MLP stands for master limited partnership, which is a limited partnership that is publicly traded in the United States.  It has the tax benefits of a limited partnership, but is traded publicly like a normal stock.

A large number of energy related companies and stocks are structured as a MLP for their tax benefits.  Note that not all energy companies are structured as a MLP.

However, its very important to note that being a MLP does not automatically make a firm more risky, more financially unstable, hold larger amounts of debt, or any of the other negative attributes that the news and media have implied by their commentary and remarks. This should be fairly common knowledge, especially to “financial experts”, analysts, editors, and news commentators.  Being such, it should make one question either the intelligence of those who make such remarks or their motives.  I would recommend being more critical of the latter.

 

History Rhymes

For the energy sector, the dropping price of oil has hit energy related companies hard (in a business sense), and as a result the market has been selling energy stocks. Many have suffered problems related to debt, financing, as well as profitability.

The quote by Mark Twain, that is often repeated by Warren Buffett is very appropriate:

“History doesn’t repeat itself, but it often rhymes”

Today’s situation in the energy sector and energy related investments very closely mirror the situation with real estate stocks & REITs (Real Estate Investment Trusts) and banks/financial institutions during the financial crisis in 2007-2008:

  • Financial rating downgrades by rating agencies.
  • Bonds falling to junk bond status.
  • Dividend/distribution reductions, eliminations, etc.
  • Difficulties raising capital and issuing debt.
  • Financial restructuring.
  • Bankruptcy & distressed situations.
  • Plummeting stock prices across all stocks in the sector/industry.
  • En masse investor selling.
  • Financial institution’s exposure to the industry/sector.

 

Just how similar is it really?

Simply make the following replacements of all instances of the following words in this entire post:

  • energy  <->  real estate
  • MLP  <->  REIT
  • limited partnership  <->  real estate investment trust

That’s darn similar isn’t it?  The only exception is that not all REITs are publicly traded, and can be privately held just like corporations.

 

The Media Circus

Like the real estate and financial crisis the energy sector has been talked about in such a way by the media where they have basically implied that the energy sector MLPs are a black hole where money goes in and will never been seen again, and if you get too close to them, you too, will be sucked in and will never see the light again!  The following are basically a reflection of what’s being said in most articles and news commentary:

  • All energy companies that produce large dividends/distributions are MLPs.
  • All MLPs are debt burdened and at risk of financial instability.
  • All MLPs are at risk of a dividend cut or entire elimination of the dividend.
  • All MLPs are doomed.
  • All investors who hold MLPs are doomed.
  • All investors who hold MLPs should sell before it’s too late.
  • All investors who are looking to invest in MLPs are fools.
  • There are no opportunities to be found in MLPs.

The “sky is falling” type commentary is of no help to investors at all.  And whether this portrayal is on purpose or out of sheer carelessness, is another story.

 

Other familiar phrases to deter investors from investing or staying in the sector are:

  • “head for the exits”
  • “junk status looms”
  • “on a slippery slope”
  • “catching a falling knives”
  • “do not touch”
  • “slashes dividend”
  • “is broken”
  • “warning signs”
  • “investors should sell now”
  • “a disaster”

Whether you are looking to invest opportunistically or assess your current energy related holdings, ignoring the noise is key.  Now that you’ve heard all the ridiculous comments, you can focus and do some work.

 

Thinking Straight

Look at the individual facts, assess the individual situations, and look towards the future, before making any decisions.  I would also like to stress, the use of the word individual.

Yes, there are some that are in trouble and may not survive. That is only one extreme end of the spectrum, and there will also be many that will come out stronger.  Not all MLPs and energy companies are like the General Growth Properties or Bear Stearns from the real estate crisis.  But the majority, if not all, will be talked about like if they were.  Remember, there was also lots of speculation, lots of fear, lots of concerns/comments raised from pundits back then.  The same is true now for energy companies.  This is where you need to run through numbers and situations before investing, as well as in assessing your current holdings. If you can’t find anything that would tell you there is something wrong, then at the end of the day, it’s also how much trust you have in the management that they know what they are doing.

And as a rule of thumb never invest such that you should be allocating into an investment that would be close to ever being able to put you in a bad financial situation.  In other words never back yourself into a corner.

Investing in distressed sectors or companies with image problems can be tough (special situations investing).  But as many value investors know (famous investors included), investing in strong companies during temporary tough times when market prices are at extreme lows, creates some of the most amazing opportunities!

 

Two Examples

Personally, these kind of situations have been the most financially rewarding.  I have two personal examples to give you from the last real estate crisis.

 

One was a mall operator who had seen it’s stock price fall from over $100 down to $5.  It was heavily owned by income investors and pensioners.  Needless to say all the phrases I mentioned above were used to describe it.  The company did cut their dividend, in order to reduce some debt but to also to reallocate towards expansion. Remember, growth is a very different situation than that of bankruptcy.  The management in place was solid and competent, with a clear focus on what it wanted to do.  That company is Macerich [MAC], one of the most sought after mall operators. It’s stock price today is near $80.

 

The other examples was a regional bank who had also seen it’s stock price fall from $40 down below $9.  Again, all of the negative phrases of doom & gloom from above surrounded it.  The company also cut their dividend -85% to bulk up capital levels.  What also made things turn from just fear into plain hysteria was that in the middle of the crisis they absorbed one of the most troubled banks in a takeover that was all over the news.  Management at this bank was solid, extremely competent, and very focused on moving forward with the future.  That bank is Wells Fargo [WFC].  It’s stock price today is above $50.

There are many other examples, but these two top-notch companies should help investors regain some focus and provide some perspective!

 

Happy New Year and Happy Investing!
* The *
* Investment *
* Blogger *
© 2015

 

DISCLOSURE:  I own shares of Macerich and may increase or reduce my holdings at any time.

Author: The Investment Blogger

I’m a private investor, who developed the “function-centric investing” paradigm. I am an investor who blogs a little here and there, rather than a blogger who invests a little here and there. I'm passionate about investing and sharing investment knowledge!

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1 Comment

  1. What do you think of the market now for MLPs? I’ve been slowly putting money in that sector for the past months

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