Inside the Markets

Insiders "bearing" the recession by being bullish. Here's why.

April 21, 2008
by Jonathan Moreland

DISCLOSURE: Readers should assume that all stocks mentioned in this column are owned by the author and/or his firm unless otherwise noted.

Despite the near certainty that the U.S. is in a recession, that Q1 earnings will contain more bad news for many firms (financials chief among them) and economic stats will get worse before they get better, I am actually leaning more bullish now than I have for much of this year.

Why the big change from a month ago? Bear Stearns.

The Bear Stearns financial meltdown is likely to be a milestone marking a near-term market bottom — just not the sort I expected. There was capitulation, but not by the stock market. The capitulation was by our federal institutions. By their actions, our regulators made it clear that they will make any and all amendments necessary to free-market capitalism in order to keep the stock market afloat. The discussion about "moral hazard" is over. Our government is for it — and for our own good.

As many CPA Insider™ readers may already know, this current little market rally and future government intervention could well be overwhelmed by bearish economic realities. But while waiting for technical signs indicating that more serious bearish action is likely, I am choosing to err on the side of moral hazard.

That said, swinging for the fences in this tricky environment is imprudent. Safer plays seem a better way for many of you and your clients to re-enter this market right now. Here's an example.


With steady, high-yielding securities in short supply these days, I continue to like energy master limited partnerships (MLPs). Insiders have as well, and my newest addition from this group is EV Energy Partners with its 8.96 percent indicated yield.

EV Energy is an upstream MLP that acquires and operates oil and gas producing properties for the purpose of generating steady cash flow. As some CPA Insider™ readers may not know, the typical MLP owns "downstream" oil and gas assets, such as pipelines and processing facilities. By contrast, "upstream" assets like oil and gas producing properties have been stowed away into income trusts.

Upstream MLPs largely failed when they first became popular decades ago. They did so because they took on too much debt and stuffed their portfolios with short-lived assets. Without the ability to hedge their exposure to volatile energy prices, their fates also twisted along with the market. That is the reason most investors these days associate energy MLPs with pipelines and other midstream assets.

With the advent of oil and gas futures in the early 1990s, however, a major risk in upstream MLPs could be hedged. Learning the lessons from past failed partnerships, successful upstream MLPs now seek to manage their properties more conservatively. Maximizing output has been replaced with managing a steady drawdown that makes future cash flows more predictable. Growth in cash flow is the result of acquiring more of these conservatively managed assets at prices that make them accretive. This brings up another factor that is different today for upstream MLPs than decades ago: a healthy acquisition market for energy producing properties.

Still, some upstream MLPs are better managed than others. EVEP appears to be one of them. This partnership increased its payout from $0.40 per quarter at the beginning of 2007, to $0.60 by the end of last year. That extraordinary growth in payout resulted from a more than 400 percent increase in EVEP's proven reserves last year, and an increase in daily production of just under 400 percent.

To be sure, that growth is not sustainable. 2007 was EVEP's first full year as a public company, and it obviously hit the ground running. Going forward, 15 percent to 20 percent growth in assets and production are all we are counting on.

The advantage of the EnerVest relationship is subtle, but real. Both EVEP and the various EnerVest partnerships selling assets have independent boards that price and approve transactions based on their fiduciary duty to maximize returns for their particular investors. EnerVest would certainly pass on any low-ball offer EVEP made for assets, and EVEP is not in the business of overpaying for properties just to help out other EnerVest investors.

The advantage comes from the fact that many of the executives at EVEP are EnerVest people. They know the properties better than competitors. This allows them to make a qualified bid quicker than rivals, and have more confidence in the reserves of those properties.

These same insiders have been adamant that EVEP's shares do not deserve their recent mark down. While EVEP is up 27 percent from lows hit in mid March, they are off by a third from highs of $42 hit last summer, when the credit crises began weighing on the sector. As shares sagged in the second half of 2007, two executives bought $984K worth of EVEP at an average cost of $33.16 per share.

As is typical, insiders acted a bit too early last year. Another bout of buying occurred in January, when three insiders purchased nearly $400K worth of EVEP for $27.58 a share. More recently, two of these persistent insiders picked up over $1 million more of their shares at an average price of $21.74.

It looks to me that insiders may have finally bottom-ticked their slumping shares. And with EVEP's high yield looking secure, I would be very surprised if this year's lows were hit again. For your investing clients who are looking for a low-risk/moderate-reward security to start bottom-feeding on in this market, EVEP is a Buy.

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Jonathan Moreland is the Director of Research at New York-based Insider Insights.com. Click here for a FREE trial issue of the firm's weekly newsletter Insider Insights.