Despite an economic downturn, the master limited partnership (MLP) sector was able to outperform the overall stock market from 2009 through 2011, due to its heavy focus on energy—and the midstream in particular. Although this streak ended in 2012, the outlook for 2013 looks strong, according to John Cusick, an MLP analyst at Wunderlich Securities.

“We really like the space on a long-term basis. I think there will be a continued drive for yield and cash flow from investors in 2013. I think the space took a bit of a breather in 2012 after three really strong years following the lows of 2008,” he tells Midstream Business.

He noted that the first few weeks of 2013 have seen the market performing well with several initial public offerings (IPOs) to start the year, including USA Compression Partners. The more recent MLP IPOs from 2012 featured several companies that are involved in businesses outside of the traditional midstream and E&P companies. Cusick says we are likely to see more of these, although the traditional MLPs will dominate the landscape.

“It seems like the definition of qualifying income from the IRS has expanded a bit with approvals being given to companies that we wouldn’t normally think of as MLPs. Generally these companies are related to the energy business, but not a typical midstream MLP as we have to come to think of them,” he said. These include Hi-Crush Partners, a producer of fracing sand; Susser Petroleum Partners, a wholesale fuel distributor; and Lehigh Gas Partners, a downstream marketing company.

Thus far, there hasn’t been much of a presence for liquefied natural gas (LNG) companies in the MLP sector, and Cusick says that for such an operation to be attractive to investors, they would require long-term contracts to lock in a base level of cash flow and provide additional security against price movements, both domestically and internationally.

The sector’s ability to remain strong is a result of the continued development of shale plays and the need to build infrastructure throughout the country to both transport and process this production. In order to meet these infrastructure demands, most MLPs will be focused on organic growth projects, according to Cusick.

Big budgets

“The larger MLP names always seem to be spending billions of dollars in capital expenditures each year, and that seems likely to continue in the next couple of years. We still need new infrastructure in the emerging plays such as the Bakken and Utica, and bottlenecks remain in the Permian and Eagle Ford,” he says.

Despite increased competition from private equity firms involved in the midstream, MLPs are still able to develop projects in a manner that is attractive to investors, Cusick says. He adds that the cost of capital is still reasonable and accessible to MLPs, as there is a large demand for yield combined with low interest rates.

This low cost of capital has been helpful to the sector given the increased costs for both materials and labor, as they haven’t caused a noticeable decrease in distributable cash flow. “I think costs would really have to spike exponentially for there to be impacts on the distribution and payout ratio,” he says.

Cusick notes that the need to raise capital while also increasing distributions can be a real juggling act for management at MLPs. “You need to reward your investors with solid distribution growth year-over-year, but at the same time, there’s an argument to be made for companies retaining capital so that they wouldn’t have to go to the capital markets as often, which would help the unit price.”

However, in his opinion, it is more important to retain distribution growth over unit growth as investors are more concerned with cash flow. It also helps to protect against the ups and downs involved in the marketplace. “I think most investors would be happy with unit prices that go sideways with solid distribution growth and yields,” he says.

While greenfield development will be the biggest tool for growth for MLPs, the acquisition and divestiture (A&D) market will remain active in 2013. Cusick anticipates this space to primarily consist of major oil companies selling off some midstream assets or midstream companies selling non-core assets.

Cusick didn’t rule out any mergers, but he doesn’t anticipate such actions to be part of the A&D mix in 2013 due to their complexity. “Mergers are always tough with MLPs because you have to satisfy four groups of unitholders: the limited partnership (LP) and general partnership (GP) holders on the acquiring side and the LP and GP holders on the side being acquired. It’s really hard because it’s almost like you have four companies trying to merge into one.”

One thing that the industry isn’t too concerned about is the possibility of the federal government opening them up to taxes as was feared for a time a few years ago. “Taxation is always going to be a possibility, but from everything we’re hearing, it doesn’t seem as though MLPs will be targeted,” he says.

The reasoning for this pull back is the efforts of the industry in educating legislators about the benefits of the MLP structure combined with the cautionary tale of what happened to the Canadian energy industry following that government’s decision to start taxing energy trusts, which were similar in structure to MLPs.

Since 2011, when the energy trusts began to be taxed in Canada, there has been a noticeable backlog in infrastructure projects as companies have slowed down their investment strategies. This has resulted in decreased jobs for Canadians and taxes for the Canadian government.

For the most part, Cusick anticipates that the MLP sector won’t face many headwinds in 2013, aside from those of the macro variety. “I don’t think there’s anything specific to the sector that will have a negative effect, but people will be concerned about the possibility of commodity prices remaining low along with the debt ceiling crisis and the global economy,” he says.

Frank Nieto can be reached at fnieto@hartenergy.com or 703-891-4807.

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