Miller/Howard General Partners Strategy
Midstream Energy with No K-1s
Midstream companies are the link between energy production and energy use. This strategy invests primarily in exchange-traded General Partners ("GP") that customarily hold interests in midstream energy limited partnerships but are not subject to K-1 tax forms.
Above Market Yields with Superior Income Growth
Master Limited Partnerships' recent distribution growth has averaged 5%. Each MLP's Incentive Distribution Rights ("IDR") structure is different but it is usually determined in a way that encourages the GP to stimulate distribution growth at the LP level. The leverage inherent in the IDR structure drives growth in cash distributions to the GP at a faster rate than growth in cash distributions to LP unitholders.
Stable Industry with Excellent Future Opportunities
Midstream energy offers growth opportunities that are likely substantially better in the long run than what traditional utilities can provide. In our view, the surge in the country's natural gas output and recent approval of new export facilities present large opportunities for natural gas infrastructure to meet the needs of both domestic and offshore markets in the years to come.
Miller/Howard General Partners Strategy invests primarily in GPs that typically hold interests in midstream energy limited partnerships but are not subject to K-1s. The universe is fairly concentrated on high quality GPs and dedicated midstream businesses structured as C corporations and traded on US exchanges. GPs with a partnership tax structure that generate K-1s are excluded from the portfolio. Stocks are US-based, multi-cap companies offering an attractive yield relative to the overall market.
The process is fundamentally driven, with keen attention to absolute value, relative value, geographic presence, management acuity, balance sheet stability, and distribution growth—a hallmark of these companies. The universe is relatively small, the portfolio highly concentrated. Given those circumstances, both portfolio stocks and stocks not held are closely monitored. With this strategy Miller/Howard can leverage decades-long investment experience in the midstream sector, focusing on companies with strong fundamentals, solid prospects, and attractive valuations.
Midstream companies are the link between energy production and energy use. Their businesses—gathering, processing, long distance transport, storage, and export—serve a stable market that has proved resistant to economic downturns, much like traditional utilities, the primary end-users of their services, and they also generate consistent cash flow. However, we believe midstream energy offers growth opportunities that are likely substantially better in the long run than what traditional utilities can provide. In our view, the surge in the country's natural gas output and recent approval of new export facilities present large opportunities for natural gas infrastructure to meet the needs of both domestic and offshore markets in the years to come.
Our objective is to create a relatively concentrated portfolio of high quality, midstream businesses with solid balance sheets and strong dividend growth prospects, considering both the GP and its underlying MLP. We seek to invest in GPs with a high dividend growth rate that can be attractive to investors, as rising dividend often lead to stock price appreciation.
Master Limited Partnerships generally consist of two entities: an operating limited partnership and a general partner. A GP typically owns a 2% interest in the operating LP and its assets. Not only does the GP receive a regular distribution from common units that it may own, but it also holds incentive distribution rights that result in an incrementally higher percentage of the MLP's distributions over time. Many GPs own a significant amount of their MLP's units, further aligning their economic interests with that of the MLP. It is not uncommon for GP dividends to grow at rates of 15%–25% or higher—levels that would be unusual for an MLP to achieve.
For a GP that owns or controls assets suitable for an MLP structure, the catalyst for high distribution growth may be a so-called drop down, or gradual sale of assets into an underlying LP. By dropping down assets into a controlled MLP, a GP can monetize assets in which a significant amount of capital may be tied up, and potentially unlock greater value.
We emphasize an individual company's fundamentals, valuation, and growth prospects. We apply a robust 'measure twice, cut once' approach before investing. The investment team seeks GPs exposed to the most dynamic energy producing areas where infrastructure support will be needed the most. Ideally, these GPs hold an inventory of assets that can drop down to their underlying MLPs. Finally, targets must have an attractive valuation and a clearly defined plan for growth.
The portfolio is highly concentrated, its universe relatively small. Turnover typically is relatively low, with an indefinite holding period for investments. At the same time given the industry's dynamics the portfolio remains flexible. We can act quickly if we believe that a company’s prospects have changed, or if its business is mispriced, or if a company may benefit from certain internal or external developments.
Strategy Inception Date: September 2014
Portfolio Manager: MHI Investment Team
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