It has been a tough year for master limited partnerships (MLPs). A sell-off in the stock market, combined with worries that rising interest rates will impact growth and investor demand, has weighed on these entities this year, sending most down by double digits. Making matters worse, the Federal Energy Regulatory Commission (FERC) recently revised one of its long-standing policies for fees collected on certain pipelines, which could have a big impact on several “low-risk” MLPs . That change sent many tumbling further this month, with the fallout continuing this week.
Among the hardest-hit in the latest round of selling were Shell Midstream Partners (NYSE: SHLX) and Dominion Energy Midstream Partners (NYSE: DM) , which declined 13% and 23%, respectively, this week. That slide came even though both companies assured investors that the policy change wouldn’t have much impact on their businesses.
Image source: Getty Images.
Nothing to worry about
Shell Midstream put out a press release this week assuring investors that the FERC “policy change is not expected to have a material impact to earnings.” That’s because most of the company’s revenue comes from contract, index, and market-based rates, not from the cost-of-service agreements impacted by the policy shift.
Not only will the change likely have little impact on current cash flow, but it also shouldn’t alter the company’s growth strategy of continuing to acquire midstream assets from its big-oil parent Royal Dutch Shell (NYSE: RDS-A) (NYSE: RDS-B) . That’s because Shell Midstream has already prefunded the next wave of acquisitions by selling $980 million in equity earlier this year; along with a $1 billion credit facility secured last December, this gives it the liquidity to buy $1 billion to $1.4 billion in assets from Shell in 2018. That plan positions Shell Midstream to grow its now 6.3%-yielding distribution another 20% this year while maintaining a healthy coverage ratio of 1.2.
Image source: Getty Images.
Not quite as clear, but still likely overreacting
Dominion Energy Midstream’s parent, utility giant Dominion Energy (NYSE: D) , also put out a statement regarding the FERC policy change. The company said that the “change in policy will take years to implement and, even then, will only impact revenues on a prospective basis from the conclusion of any ratemaking process.” As a result, Dominion Energy Partners “does not anticipate any revenue reductions in the 2018 to 2020 time period due to FERC’s actions and is still evaluating any long term impacts and their timing.” What’s noteworthy about this statement is that Dominion didn’t use the same language as Shell Midstream, which flatly stated there would be no material impact. That subtle difference is likely why Dominion Midstream’s valuation took a bigger hit this week.
Aside from the uncertainty about a potential decline in revenue, the other concern is that this policy shift might alter Dominion Energy’s plans to drop down assets to its MLP . That drove an analyst at Bank of America to downgrade Dominion’s stock this week from buy to neutral, citing the potential for this strategy to no longer create as much value for the company as expected. That came even though Dominion attempted to ease those concerns by saying it could drop down its newly built natural gas export terminal to its MLP instead of more pipelines, if that would create the most value. Because it has other options to drive growth, Dominion Energy Midstream still believes it can grow its now 7.6%-yielding payout at a 22% compound annual rate through 2020.
The uncertainty increases the risk but also the opportunity
There’s heightened uncertainty in the MLP space after FERC’s abrupt policy change, which could continue weighing on the sector for quite some time. There’s a risk that some companies might have underestimated the impact, which could eventually cause them to slow their distribution growth rate, or worse yet, reduce the payout.
That outcome, however, appears less likely for these two companies; this week’s sell-off, particularly in Shell Midstream, looks like an overreaction. While it doesn’t necessarily make these stocks screaming buys, investors with the stomach to handle the likely near-term volatility could score an attractive total return in the coming years by pouncing on this opportunity.
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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends Dominion Energy, Inc. The Motley Fool has a disclosure policy .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.