AMZ-Treasury yield spread
The yield spread between the Alerian MLP Index (^AMZ) and the ten-year Treasury has narrowed. AMZ was trading at a yield spread of 4.8% to the ten-year Treasury yield by the end of the week ending June 8—slightly higher than the five-year average of 4.6%. However, the current spread is lower than the one-year average of 5.3%. The narrowing of the spread is due to the recent MLP rally and rise in US Treasury yields.
The FOMC is expected to hike the policy rates this week. The rake hike might already be priced in, but hawkish commentary would likely put pressure on the ten-year Treasury yield. The pressure might cause the spread to narrow. However, AMZ’s yield would likely adjust to the increased Treasury yield, which would result in a flat or wider spread.
A rise in US bond yields makes MLPs, which are generally high yielding, look relatively unattractive due to their higher risk. A high bond yield leads to a higher cost of capital for MLPs.
Are MLPs getting expensive?
So far, the US Treasury yield has risen by 53 basis points since the beginning of 2018. At the same time, AMZ’s yield has increased by 12 basis points, which indicates that the decline in the spread is mainly due to a rise in the Treasury yield.
The top MLPs by market capitalization, Enterprise Products Partners (EPD), MPLX (MPLX), and Energy Transfer Partners (ETP) are trading at forward EV-to-EBITDA multiples of 13.6x, 12.1x, and 10.8x. They’re still trading below their last five-year average of 14.4x, 13.4x, and 10.9x, respectively.
MLPs current valuation might indicate a buying opportunity considering their improved balance sheet position, higher crude oil prices, lower counterparty exposure, and increased drilling activity. Higher drilling activity indirectly drives midstream MLPs’ throughput volumes. In fact, the US energy sector looks like a good value play among all of the major US sectors. Read Sector Stoplight: Is Your Favorite S&P 500 Sector Getting Expensive? to learn more.
However, a higher-than-expected rise in US Treasury yields and the recent downtrend in crude oil prices could concern MPLs, particularly midstream MLPs.
Next, we’ll discuss MLPs’ rating updates last week.