No. of Recommendations: 14
I might have mentioned on our Board that I own EEQ, which is the Enbridge MLP that pays its dividend in stock rather than cash, and thus avoids the UBI or K-1 issues that we normally encounter with MLP investments. Its “sister” MLP, with regular cash distributions and K-1s, is EEP.

Over the past five years, EEQ has performed pretty well, easily beating its benchmark, the Alerian MLP index. See However, over the past 12 months it’s been an entirely different story. In 2013 the stock is down, but by only 1%. It took a big hit last Friday (down 2.6%), rebounded earlier this week, then fell off with the broader market.

I spent a bit of time trying to figure out what was ailing EEQ, with a view towards deciding whether to buy more, hold or dump it. The first issue is that EEQ has missed its guidance and consensus estimates – badly. Q4 adjusted net income fell from $.32 to $.18 (consensus was $.25) and, for the year 2012, declined from $1.39 to $.99. The company acknowledges that distributable cash flow (a term that’s not defined in the press release) was 70% of the actual rate of distribution of $2.17 per share – so the company is significantly overpaying its dividend.

What’s the culprit behind these disappointments? There are several concerns. Perhaps the most significant is that EEQ is fairly sensitive to natural gas and natural gas liquids (NGL) prices; these have been weak, due to oversupply, and this has caused EEQ to badly miss its earnings projections and consensus estimates. For Q4, adjusted operating income per share was down 18%. Management professes not to worry, claiming that “the partnership’s distributable cash flow growth will begin to accelerate once our accretive growth projects (they are referring to pipeline expansions) enter service.”

Well, maybe. But for now, they are paying $2.17 per share in distributions, but “distributable cash flow,” by the company’s own estimates, is only $1.71. As we know, it is never a good sign when a company overpays its dividend like this, or when earnings in the basic business is declining. Shareholders should not expect an increase in natural gas or NGL prices over the near term, and must count on a very successful pipeline expansion.

EEQ isn’t exactly a cheap stock, selling (at $28.61) for 16.7x the company’s estimate of its distributable cash flow. And we should keep in mind that income per share (and even adjusted income per share) is a lot less than “distributable cash flow,” which presumably adds back depreciation and makes other adjustments that are not apparent from the company’s press release or 10-Q. I am not smart enough to be able to compare the “distributable cash flow” of an MLP with the AFFO of a REIT; the latter is a measure of truly free cash flow, but I don’t really understand how the former is calculated. As I mentioned, neither EEQ’s nor EEP’s Q4 press release defines that term; they discuss other metrics such as net income per share, adjusted income per share, and ebitda.

Another concern is debt and the need to raise capital. From looking at the Q4 conf call transcript, it seems that EEQ/EEP needs to raise $7.5 billion through 2016 to fund their pipeline expansion plans. This is a large number in the context of the total equity market cap of both EEP and EEQ (about $9.5 billion). They will need to raise a lot of equity, along with more debt. Can they do it at reasonable prices? I don’t know. If one can rely upon Yahoo Finance figures, debt is $6B at EEP, or 42.2% of its total enterprise value. This isn’t troubling, but the leverage ratio will probably increase.

There is also a new issue: increasing competition from railroads, which are shipping LNG product at cheaper prices per mile from some of the company’s markets. There is a discussion of this in the Q4 conf call transcript and, based on the analysts’ questions, it seems to be a new concern. It is hard to assess whether this is a long-term, or just a short-term, threat.

I have never been a fan of consensus estimates or investment ratings. However, smoothing out a group of them may filter out excessively optimistic and pessimistic opinions. I think it’s interesting to note that EEP (the K-1 version of EEQ) ranks very near the bottom of MLP investment ratings as compiled by Thompson Reuters. See This, too, is a bit worrisome.

The bottom line is that, despite its high dividend yield of about 7.6%, I am not as comfortable with this stock as I once was. That high yield tells us a lot about investment safety; many other pipeline MLPs of similar size have dividend yields that are a lot less. For example, El Paso Pipeline Partners yields 5.8% and Plains All American yields 4.2%.

I have a very modest profit in EEQ, and have been earning a dividend yield of over 7% since I bought it. I decided to sell my EEQ. I like the pipeline industry, and MLPs generally, but there are very few effective ways to invest in them in IRAs, where the vast bulk of my investment assets are located, if one wants to avoid the UBI issue.

Yes, I know Kinder Morgan has an MLP that’s similar to EEQ. But I don’t like the fee structure between KMR and the general partner (KMI), which seems overly generous to the latter entity. I am not aware of any other MLP besides EEQ and KMR that clearly avoids the UBI issue, except for ETN notes and such. Any suggestions would be welcome. Thanks.

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