The High Yield Market Reconnects with MLPs. Is the Optimism Warranted?Posted on May 25, 2020
By: Caesar Silvestro
After a period of discomfort with MLPs, it appears the marketplace has turned constructive on the group. During the mid-March to mid-April High Yield route, MLPs greatly underperformed the aggregate market. MLP pundits claimed the MLP business model to be broken. The decline in oil prices and a dramatic reduction in demand stemming from the recession would leave the sector over-levered with excessive capacity. MLP yields that once traded at a premium to the market, suddenly traded at significant discount. The ADI Midstream Index indicated aggregate yields were +200 bps to the High Yield Market Index at the end of March.
Sentiment quickly rebounded. The US government’s aggressive fiscal and monetary response coupled with an improved global COVID conditions seems to suggest that demand for liquids would quickly recover. Oil prices improved after US producers’ shut-ins and OPEC’s agreement. In addition, MLPs reigned in capital expenditures and cut dividends to bolster their balance sheet. MLP spreads have screamed tighter, and the ADI Midstream Index now trades at a lower yield in comparison to the aggregate market.
However, risks remain for MLPs. US producers have greatly curtailed their production, and the timing and magnitude of its return is uncertain. In addition, a number of producers will likely go out of business due to excess capacity. These events will reduce MLPs’ volume and increase their leverage.
In considering MLPs, it is important to think about companies with strong balance sheets, good hedging programs, solid counterparties, and meaningful liquidity.
Caesar Silvestro has nearly 20 years of buy-side and sell-side research experience in the High Yield and Distressed markets. He was an Executive Director at BBVA Securities focused on the Energy Sector and an Executive Director at MF Global overseeing the Distressed/High Yield research effort. He holds a MBA in Finance from NYU Stern School of Business and is a graduate of Franklin and Marshall College.
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