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Stock Strategist Industry Reports

All Is Not Lost in Midstream Meltdown

There are still operators with solid balance sheets, strong distribution coverage, and low costs of capital.

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The midstream sector has traded off sharply in 2015, with the JPMorgan Alerian MLP Index down approximately 43% year to date. Selling in the fourth quarter accelerated, owing to the spillover effect from  Kinder Morgan (KMI), which slashed its dividend 75%. So far in the fourth quarter, the Alerian index is down 11% while Kinder Morgan is down 41%; on a year-to-date basis, Kinder Morgan is down 61%. The read-through for the rest of the midstream sector, while ominous because of Kinder Morgan's outsize presence, depends on each individual midstream operator's circumstances. The challenging commodity markets certainly played a role in Kinder Morgan's dividend reduction; however, the company was fairly leveraged going into the downturn and was thus more vulnerable than many of its more prudent peers. As such, we do not believe all other midstream operators are doomed to Kinder Morgan's fate, although a handful of similarly overleveraged firms could follow suit. Included in this ill-fated group are the Plains, Oneok, and Williams families.

Beyond these names, we expect the entire sector will need to re-evaluate capital-expenditure programs, with an eye toward high-grading in order to focus on projects with the highest return potential. Companies in the sector should also review their financing plans for 2016 in the wake of sharply higher costs of capital and the likelihood of higher interest rates next year. Broadly, we expect midstream operators to focus on protecting their balance sheets next year and on maintaining, where applicable, their investment-grade ratings. We also expect interest rates and commodity prices to remain headwinds and capital markets to remain volatile, making it challenging for midstream operators to fund their capital expenditure programs next year.

Stephen Simko does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.