Irrational Pessimism – Throwing The Baby Out With The Bath Water
Since first publishing kortsessions.com in February 2013, I have tried not to get into the weeds on individual stocks ideas. We are all about the media and the adverse outcomes in store for those who rest their investment policy on their pronouncements. When I did mention a name for illustrative purpose, I did my best to make certain that I acknowledged my fallibility and ownership position (if I had one), and to advise all readers consuming my work to make certain companies mentioned were suitable to their own investment circumstance and tolerance for risk before they considered purchase… caveat emptor. Today’s post is going to sound like a recommendation. But because of the irrational pessimism surrounding a certain segment of the market, the securities covered have great illustrative value. Nonetheless, I urge you refer to the admonition in paragraph one before rushing out and buying any of the two names that I will refer to. I own positions in both names. Background of the craziness My example today comes from a former client, Tortoise Capital Advisors . As their name implies, “Slow and steady wins the race.” They are not trying to hit the ball out of the park every time they come to the plate. Singles do just fine. Tortoise manages both separate accounts, closed-end, exchange-traded funds and open-ended funds (AUM $13 billion), the majority of which specialize in the shares of Master Limited Partnerships (MLPs). I have owned their shares in the past, and recently initiated positions in their flagship fund, the Tortoise Energy Infrastructure Corporation (NYSE: TYG ), and the Tortoise MLP Fund (NYSE: NTG ). These two funds, in particular, are midstream (processing, storage and pipelines – not production ) oriented. They are conduits and not terribly sensitive to commodity prices. The management at Tortoise is very conservative. I can vouch for this from personal experience. As an institutional broker with both A.G. Edwards and Wells Fargo, I had the opportunity to bring managements in for meetings with their PMs and analysts. I will attest that they were an extremely tough sell. They have scrupulously avoided commodity risk and the risk of anything questionable in financing plans/needs and capitol structures (excessive leverage). They looked for simple businesses with long-term repeatable revenue streams. They did their homework. Both TYG ($23.58, yielding 11%, a/o-2/26) and NTG ($15.20, yield 11%, a/o- 2/26), after making all-time highs in 2013 ($50.64 and $30.18 respectively), began precipitous declines in 2014. Interestingly, TYG, because it had the word “Energy” in its name, began to plummet first; even though none of its MLP investments owned oil and gas reserves or production. Its holdings were all fee-based conduits, storage or processors, whose prices had collapsed due to oversupply issues in commodities that they transported, but whose demand (ergo, fee-generating capacity) continued to grow. This was crazy, but par for the course for the stock market. Linn Energy LLC (NASDAQ: LINE ) and Kinder Morgan, Inc. (NYSE: KMI ) exacerbate matters In the case of Linn, it is an upstream (ergo, highly exposed to commodity risk via owned oil and gas production) MLP that came under bear attack for its hedge accounting (completely unwarranted). The company made a large acquisition, with the idea that it could swap out pieces for lower-risk producing assets and sell equity to finance the rest. It did this on the credit card. The crude market turned. Linn Energy could not sell or swap assets. When oil collapsed, its stock price collapsed. The company could not sell equity to pay down debt. Linn’s stock, which at one time traded as high as $42, is now less than $.50 per share. Importantly, Linn and the upstream partnerships are outliers. Though midstream MLPs, for the most part, have little commodity exposure, investors did not want to be confused with the facts and sold. KMI was another case of a bear attack on what was considered at one time “best of breed” in the midstream MLP space. It was also a situation where an acquisition was made in a market that was not sympathetic to financing MLPs. Ergo, to put itself back on sound financial footing (which it did – see here ), the company slashed its dividend 75%, proving the naysayers correct and causing further group-wide liquidation… throwing the babies out with the bathwater. The Elephant in the Room: Is the MLP model broken? According to Tortoise portfolio manager, Matt Sallee …Looking at the facts, midstream MLPs, their fundamentals are not broken. Our portfolio has average cash flow growth of 20% year over year looking at EBITDA, 10% per unit. And while not every company has announced their 4th quarter distributions, north of half of our portfolio has, and that weighted average distribution as I mentioned previously is up about 3% over the prior quarter, so we feel pretty good about that. Along with that, our MLP portfolio companies, have not experienced any distribution cuts. You read that? Over half their portfolio companies in the last year increased distributions with no distribution cuts! Source: Transcript of Tortoise first quarter 2016 conference call (Additional context: Video presentation by Tortoise CEO, Kevin Birzer) How irrational has the pessimism been in the MLP space? My favorite recent example came on January 20, 2016. In the wake of a horrific (pardon my sarcasm) 1/4 point increase in the Fed Funds rate, a continuing collapse in the price of oil, the Chinese market in free fall, a potential European banking crisis (punctuated by rumors of problems at Deutsche Bank AG (NYSE: DB )), the market opened and fell almost immediately by 550 Dow points. During the panic selling that ensued, TYG hit a low of $18.50 (yielding 14%) and NTG fell to $11.60 (yielding 14.5%). Don’t confuse us with the facts! We can’t stand this anymore! Get us out! The above panic is a descriptive of what one normally sees at a market bottom, not at a top … an example of – “… nameless, unreasoning, unjustified terror … (- Franklin D. Roosevelt ).” It is Irrational Pessimism of the highest order. I believe that the MLP space is a good proxy for much of the craziness afoot in today’s market… healthy babies being tossed out with the bath water. What is your take? Disclaimer: The information presented in kortsessions.com represents my own opinions and does not contain recommendations for any particular investment or securities. I may, from time to time, mention certain securities for illustrative purpose, names where I personally hold positions. These are not meant to be construed as recommendations to BUY or SELL. All investments and strategies should be undertaken only after careful consideration of suitability based on the risks, tolerance for risk and personal financial situation.