|
To spur the development of vital energy infrastructure assets,
Congress essentially granted MLPs an exemption from
federal income taxes. But favorable tax treatment is only one
reason why income investors have flocked to this group.
Could the attraction also lie in their highly stable business
models? Or their outsized, double-digit yields? Or their ability
to hike distributions +8-10% per year like clockwork?
Yes.
Heads We Win, Tails You Lose
The vast majority of MLPs operate in the energy business.
Specifically, these companies own and operate networks of
long-lived assets ranging from pipelines to liquefied natural
gas (LNG) terminals, which they use to transport, process and
store crude oil, natural gas and petrochemicals.
In short, these critical "midstream" functions serve as a vital
link in the chain enabling oil/gas producers to get their
products from the ground to the market. And this business has
some highly attractive features:
 Aside from routine maintenance, pipelines and other facilities
don't require much in the way of ongoing capital expenditures
and can stay in service for decades.
Most companies have staked out different territories, and
since overlapping pipelines are rare, competition tends to be
minimal in many regions.
Unlike other sectors, disruptive new technologies and product
obsolescence aren't much of a threat -- pipelines aren't going
out of style anytime soon.
In general, MLP income is based largely on the volume of oil
and gas flowing through the system, not the prices of the
underlying commodities.
Pipelines that cross state lines are often regulated at the federal level, with rates tied to the Producer Price Index, so
tariffs ratchet higher over time to match inflation.
Because MLPs aren't involved in the actual production and sale
of commodities, many pipeline owners care little whether crude
slides to $25 or springs back to $100. As long as oil and gas
are flowing through the system, the company responsible for
moving it is well-compensated for its services.
Not too many industries can count on inelastic demand, natural
barriers to entry, strong operating leverage, and (to one degree
or another) insulation against fluctuating prices. So it's not
surprising that MLPs are famous for their ability to generate
highly stable and predictable cash flows in both good times and
bad.
And just like utilities, these mature companies have little need
to retain profits and usually return them to shareholders
(technically known as "unitholders" in partnership lingo) as fast as they take them in. In fact,
with their "pass-through" structure and light capital spending
requirements, MLPs typically distribute about 90% of their cash
flows each quarter -- and in this case, Uncle Sam doesn't take a
cut of the proceeds.
The Tortoise and the Hare
As we've seen lately, commodity prices can fluctuate wildly from
day to day -- or even minute to minute. But demand for crude and
natural gas is fairly level and increases at a slow, but steady
pace each year. Most experts agree that the world's oil
consumption (which now stands at 85 million barrels per day)
will go right on increasing at
a +1.25% annual clip over the next
20 years.
That
might not sound like much, but consider that most MLPs are also
busy making acquisitions and pursuing growth initiatives. By
expanding pipeline systems and taking other such steps, firms
can rake in more cash even if product volume remains flat.
More cash to the company means a rising stream of dividend
distributions for investors. Over the past decade, MLPs have
parlayed gradually rising demand, built-in inflation adjustments
and billions in expansion projects into dependable +8-10%
average
annual distribution increases.
As you can see from these widely held
MLPs (which are commonly
found in nearly all MLP funds), those steady increases can
really add up over time.
|
Company |
2006
Dist. |
2007
Dist. |
Current Dist. |
5-Yr.
Div. Growth Rate (CAGR) |
Current Yield |
|
Magellan Midstream (NYSE: MMP) |
$2.29 |
$2.49 |
$2.81 |
+12.9% |
8.2% |
|
Enterprise Products
(NYSE: EPD) |
$1.80 |
$1.92 |
$2.12 |
+8.2% |
9.6% |
|
Energy Transfer (NYSE: ETP) |
$2.01 |
$3.19 |
$3.57 |
+22.6% |
10.3% |
|
Plains All-American
(NYSE: PAA) |
$2.87 |
$3.28 |
$3.57 |
+10.3% |
9.4% |
|
Salute the General
Cash-generating machines like Enterprise Products Partners have
increased distributions by nearly +50% over the past five years.
Meanwhile, since its IPO in 2001, Magellan Midstream Partners
has raised its dividends for an impressive 30 quarters in a row.
Over that span, investors have watched their annual payments
surge more than +150%.
Special Offers
|
 |
Get Investor's Business Daily
FREE for two weeks.
Learn
More
|
|
 |
|
Risk free
trial of our live e-mini futures trading room.
Learn
More |
|
|
|
|
While an impressive track record is nice, it's what's on the
horizon that matters most. Fortunately, most MLPs have multiple
projects cooking that should drive cash flows significantly
higher once they come online. These growth initiatives are
welcome news for companies like Enterprise and Magellan -- but
it's the general partners in charge of these firms that really
stand to be showered with cash.
As you may be aware, partnership status comes in two flavors: limited partner
(LP) and general partner (GP). The GP typically handles all of
the day-to-day business operations and in return gets a cut of
the distributions that are dished out to the limited partners.
As an incentive to get the most out of the company's assets, the
GP is paid on a sliding scale that ratchets upward along with
payouts.
These incentive distribution rights reward general partners with
a fatter slice of the pie over time. To see this in action, look
no further than Magellan. The firm's limited partners just
received a +9% year-over-year dividend hike last quarter.
Meanwhile, the general partners were treated to an increase of
+22%, more than double.
Typically, GPs trade at a premium because of their faster
growth. But today, many are attractively priced and have similar
or even higher yields than their underlying LP.
The Price Is Right
I would be remiss if I didn't mention that for all their
benefits, MLPs can create some headaches at tax time.
Distributions are usually a mixture of net income and a return
of capital (an allowance for depreciating assets). In general,
the portion deemed a return of capital simply reduces your tax
basis and isn't taxable until the shares are sold. For more
information, this
primer
might help.
Fortunately, those who invest in this sector through a fund
rather than individual stocks can bypass most of these
complications and receive a streamlined 1099-DIV form instead of
a K-1 partnership statement. Still, you may want to consult your
tax advisor before investing.
In any case, it's easy to see why MLPs are prized for their
unique mix of stability, income and growth. And after this
historic sell-off, there has arguably never been a better time to
invest in this attractive sector.
As you can see from the table below, valuations have been pushed
lower and lower, allowing MLP yields to rocket into uncharted
territory.
I can't think of a more opportune
time to check out some of the attractive closed-end funds that
specialize in MLPs.
-- Nathan Slaughter
Editor
The ETF Authority
Raising the Bar
According to Bloomberg, profit forecasts have shrunk
across the board for every industry. There are now more
than 3,500 companies whose 2009 EPS estimates are lower
today than they were 90 days ago. But which of these
companies is actually raising its earnings estimates
from $3.49 per share in 2009 to $3.80, with some of the
more optimistic projections even calling for $4.00?
A.)
Apollo Group (APOL)
B.)
General Motors (GM)
C.)
Home Depot (HD)
D.)
Philip Morris (PM)
E.)
Starwood Hotels (HOT)
(Please
click on one the links above. After you make your choice, we'll show
you the correct answer on our web site.)
|
TopStockAnalysts
http://www.TopStockAnalysts.com
839-K Quince Orchard Blvd.
Gaithersburg, MD 20878-1614
P.S. -- If you're not already a subscriber to one of
StreetAuthority.com's premium investing newsletters, which include a wealth of
additional information and specific investing guidance that you
won't find anywhere else, then please visit the following
page to learn more: http://www.StreetAuthority.com/subscribe.asp
|