MLP yields increased through 3Q, but cost of equity remains low
MLP equities traded down slightly during the third quarter, a slight negative for the cost of equity capital
The cost of equity capital across most of the MLP spectrum was up for many MLP names over the third quarter. When the cost of equity capital increases, it’s negative in the sense that it’s more expensive for MLPs to fund growth and makes fewer growth projects and acquisitions attractive. The upside of this is that more expensive equity capital inherently comes from higher MLP yields as a result of stock price depreciation, providing a potentially attractive entry point.
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Using the Alerian MLP ETF (AMLP) as a proxy for the MLP universe, dividend yields increased slightly over the third quarter. For the AMLP, the dividend yield at September 30 was 6.12%, compared to roughly 5.92% at June 28.
For Enterprise Products Partners (EPD), which has a $56.5 billion market cap and is one of the largest MLPs by market cap, the dividend yield was 4.46% on September 30, compared to 4.31% at June 28. Another large-cap MLP, Kinder Morgan Energy Partners (KMP), which has a $34.5 billion market cap, had a dividend yield of 6.61% on September 30, compared to 6.09% at June 30.
The dividend yields on small- and mid-cap MLPs also generally increased. Targa Resources Partners dividend yield (NGLS), which has a $5.5 billion market cap, increased slightly, as the company had a dividend yield of 5.56% on September 30, compared to 5.53% at June 28. Genesis Energy (GEL), which has a $4.4 billion market cap, had a dividend yield of 4.07% on September 30, compared to 3.84% at June 28.
MLP yields are down significantly since the financial crisis
Though recently, MLP distribution yields have increased slightly, from a longer-term perspective, MLP yields have compressed dramatically since the financial crisis. So raising funds by issuing equity had become a more and more attractive option over the past few years, as the cost of equity has continued to cheapen. During the financial crisis of 2008, yields on the aforementioned MLP stocks spiked up from ~10% (KMP) to over 30% (NGLS) as compared to levels of ~4% to 7% now on the same names.
Cheaper equity capital means more growth projects may be attractive
Again, the long-term yield compression on MLP stocks has been a positive for growth because generally speaking, the lower the cost of funds, the more projects a company may find attractive. For example, if a company has identified a project that has returns of 15% and the company’s cost of funds is 10%, the project may be pursued. If the cost of funds increases, for example to 20%, the same project may no longer be viable to the company. Usually, the more attractive projects a company is able to pursue and fund, the greater the likelihood for an increase in a company’s assets and cash flow.
Currently, despite the slight increase in yields over the third quarter, equity capital remains relatively cheap for MLPs. This helps fund MLPs’ growth, which is positive for the companies. The equity financing environment is an important factor for the majority of MLP names.