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"While we believe we are in oversold territory (and stocks are beginning to screen attractive long term), timing towards any sustained near-term relief remains very uncertain," wrote Morgan Stanley analysts Monday in a report on the Midstream Energy sector. They argued MLPs were getting caught up in the "energy macro trade."
MLPs, like real estate investment trusts, distribute most of their income directly to shareholders in the form of dividends. They generally tend to be in the energy transportation and storage businesses, which are less prone to price swings than oil producers. But MLPs have been hurt just as badly this time around. The benchmark Alerian MLP Index is down some 19% over the past three months, slightly less than the 22% drop in the Dow Jones U.S. Oil and Gas Index.
An MLP's dividend payout depends upon its ability to generate steady cash flow while growing through acquisitions. However, cash flows are expected to decline as energy producers cut back on production and balk at paying more to get oil and gas to market. MLPs also rely on the high-yield bond market to fuel growth through acquisitions. But they haven't been able to issue high-yield bonds for the past two months as bond investors grow wary of risks and demand prohibitively steep interest payments from MLPs.
A Goldman Sachs research report published Monday cited Linn and Niska as among the biggest underperformers in the sector. Niska shares were down 32% last week ahead of Monday's open and shares of both Linn and LinnCo (LNCO) (a separate company that invests exclusively in Linn) were both down about 27%. On Monday, shares of Linn and LinnCo were down 15% and 16%, respectively, while Niska shares were up 3.5%.
Goldman cited LinnCo as a top pick on both a total return and yield basis, even though it is officially neutral on the stock. Goldman analysts did not state their own view on gathering and processing companies such as Linn, but stated that the subsector "continue[s] to draw strong interest," while adding that "investors prefer to stay on the sidelines until crude prices stabilize."
In its own report on MLPs, Morgan Stanley analysts declared themselves "cautious near-term as we have little conviction given macro uncertainty." However, they "see an improving long-term risk-reward," while adding that "the path and timing remain murky."
They urged investors to "remain defensive and focus on quality."
Oppenheimer on Monday urged caution on MLPs in general, but particularly MLPs of companies focused on exploration and production. They downgraded Legacy Reserves (LGCY) Mid-Con Energy Partners (MCEP) , Memorial Production Partners (MEMP) and New Source Energy Partners (NSLP) .
"Given continued deterioration in oil prices and rising current yields on the [exploration and production] MLPs, distribution cuts become more likely, more extensive and potentially sooner than previously anticipated," wrote Oppenheimer's analysts. "Management options to offset declines from lower oil prices are limited in an environment of 21.4% average current yields," they added.
Oppenheimer analysts also urge investors to focus on what they consider defensive picks, which they describe as "fee-based midstream energy infrastructure companies."