Master limited partnerships have some dandy advantages, but none sweeter than the jumbo dividends they pay. Think of them as the new REITs.
By Jon Markman
With gasoline and electricity prices soaring across the country, it's time for consumers to fight back with the most awesome weapon they've got.
No, not a sledgehammer for your local gas pump or walking shoes for your commute, or even a solar-power generator for your margarita blender.
It's your investment portfolio, my friends. The theme of this idea is that if you can't beat 'em, join 'em. There's a way for you to pour money from your tank right back into your bank account.
With timely, substantial stakes in a relatively new class of energy stocks that pay big, safe dividends, you can make enough steady income to pay for all your gasoline needs and then some. One nice thing is that this class of stocks is not very volatile, as it reacts little to change in the broad market or energy prices.
The formal name of this group of stocks is "master limited partnerships," or MLPs, but now that I've got all of those syllables out of the way I'll try not to repeat them. MLPs don't have any relation to energy partnerships that were sold on the private market years ago as passive tax shelters, and you are really not partnering in business with anyone.
MLPs are a group of securities that you can buy and sell just like normal stocks but with one big difference: By law, most of them provide a quarterly dividend, or cash payment, that is enormous relative to their price. (Another difference, while minor, needs to be noted as well: They have some tax-related eccentricities that may give your accountant a headache when you sell.)
Fill 'er up
How high are MLPs' dividend yields? Very, very high compared with most stocks and quite high even compared with most utilities. The average dividend yield of the 100 largest S&P 500 Index ($INX) stocks is 1.8%, and the average dividend yield of the 15 stocks in the Dow Jones Utilities Index ($UTIL) is 2.9%. Yet the average yield of the 50 leading MLPs is a whopping 6%, and many pay 7% or more.
If you don't know much about dividends because you've been a growth-stock investor all your life, here's some math to help you understand why they're so cool. It's like a pre-algebra word problem:
- According to government statistics, the average person drives 12,200 miles a year in a vehicle that gets 21 miles to the gallon.
- According to energy industry statistics, the average price of a gallon of gasoline nationwide over the past year was $2.50.
- Divide 12,200 by 21, and you'll see the average person uses about 580 gallons of gas annually. Multiply that by $2.50, and you'll see the average person spends about $1,450 per year for gasoline.
- So how much money do you need to put into an investment that yields 6% per year to get $1,450 in annual income? I'll spare you the rest of the equations, but the answer is about $24,000.
If you put about $24,000 of your investment portfolio into a set of MLPs, in other words, they'll throw off enough income to pay for an entire year's worth of gasoline.
Though that's pretty awesome by itself, where it really gets interesting is that MLPs have done a great job of providing capital appreciation as well. In fact, since 2000, an index that tracks these securities, called the Alerian MLP Index ($AMZ.X), is up 240%. One of the largest companies in the group, Enterprise Products Partners (EPD, news, msgs), is up 330% over that span, while another company, MarkWest Hydrocarbon (MWP, news, msgs), is up more than 1,100%.
I probably don't need to remind that you that the S&P 500 is down 2% over that period, while the Nasdaq-100 Index ($NDX.X) is down 50%.
A boost from a tax-law change
MLPs are an invention of mid-1980s federal tax policy designed to encourage investment in "midstream" energy assets. The companies in the sectors are primarily involved in the gathering, transportation and storage of crude oil, natural gas, coal and refined products, such as fuel oil and natural-gas liquids. They own the pipelines, storage tanks, terminals and tankers that move energy from the place where it is sucked out of the earth to the places where it is processed and used.
For their first 15 years, MLPs got little publicity and were bought primarily for their income by high-net-worth individuals on the recommendation of savvy financial advisers. They were not bought by institutions, mutual funds or foreigners because of a quirk in the way their distributions are taxed. They therefore got little research coverage at brokerages and traded in low volume.
A late-'90s change in tax law increased their attractiveness to institutions, and subsequent changes in their corporate structure have started to attract an array of individuals. The latest catalyst for increased interest is investors' waning interest in real estate investment trusts, or REITs, which now pay relatively low dividend yields, are tarred by the crisis in residential mortgages and have advanced to the point where they are pretty expensive on a valuation basis.
Indeed, it's now fair to think of MLPs as the new REITs. You can buy them for income and enjoy a lot of price appreciation as well, as many of the companies involved in the gathering and distribution of energy are growing rapidly by acquiring competitors and by simply building more assets from scratch. They do not tend to trade up and down with crude-oil and gas prices because their revenues are tied to the sheer movement of energy, not its price.
Sanity in a hot sector
Because these companies must pay a big dividend out of their earnings stream every quarter, they tend to be a lot more prudent about their purchases and construction projects than, say, technology or industrial companies that might make a big, splashy move just to satisfy the ego of their chief executives. And they are usually rewarded quickly for these efforts. As an example, natural-gas-pipeline owner and processor Copano Energy (CPNO, news, msgs) on Friday announced it would buy pipeline operator Cimmarron Gathering for $95 million to expand its footprint in the Midwest. Wall Street loved the idea: Analysts revised earnings estimates higher, and the stock jumped 4.5% Monday. Copano shares are up 74% in the past 12 months, including dividends.
If anything, you can think of MLPs as a pure play on the growth in demand for energy without having to worry about whether crude oil is going to $30 or $100. Demand has been advancing at a steady 1.5% pace for years, even in sharp recessions and at all price levels.
One note of caution: High-dividend stocks typically are thought of as safe, steady investments because a falling stock price makes the dividend yield increase (provided the dividend stays constant), thus making it less likely the stock price will fall very far. But because some MLPs have seen such huge price gains in recent years and because their dividend yields have kept pace, it's possible that the stock prices could fall relatively quickly, too, as the relatively flexible payouts might not provide a solid floor under the share prices.
There are no mutual funds or exchange-traded funds that track MLPs, but there are a couple of successful closed-end funds, such as Kayne Anderson MLP Investment (KYN, news, msgs). It's not that hard to build your own diversified portfolio of them, though, so you might as well do it yourself and save the fees.
The following table lists the MLPs that are currently ranked best by MSN Money's StockScouter rating system. For those of you who wish to wait and see, rather than act and reap the rewards, I will track them over the next year and report back on their progress.
Top-rated MLPs
| Company | Market cap |
Dividend yield % | Scouter rating* |
April 9 close | Industry |
|---|
| Inergy (NRGY, news, msgs) |
$1.6 B | 6.74 | 8 |
$33.37 | Propane distribution |
| Teppco Partners (TPP, news, msgs) |
$4.0 B | 6.02 | 8 |
$45.00 |
Oil and gas pipelines |
| Holly Energy Partners (HEP, news, msgs) |
$771 M | 5.64 | 8 |
$47.54 |
Oil and gas pipelines |
| Alliance Resource Partners (ARLP, news, msgs) |
$1.4 B | 5.49 | 8 |
$39.37 |
Coal mining and distribution |
| Sunoco Logistics Partners (SXL, news, msgs) |
$1.7 B | 5.41 | 8 |
$59.59 |
Oil and gas pipelines |
| Global Partners (GLP, news, msgs) |
$400 M | 5.24 | 8 |
$34.41 | Oil and gas refining |
| Calumet Specialty Products Partners (CLMT, news, msgs) |
$793 M | 4.95 | 8 |
$49.40 | Oil and gas refining |
| TransMontaigne Partners (TLP, news, msgs) |
$262 M | 4.79 | 8 |
$36.12 |
Oil and gas pipelines |
| Copano Energy (CPNO, news, msgs) |
$1.6 B | 4.58 | 8 |
$36.45 |
Oil and gas pipelines |
| Boardwalk Pipeline Partners (BWP, news, msgs) |
$2.7 B | 4.51 | 8 |
$36.90 |
Oil and gas pipelines |
| DCP Midstream Partners (DPM, news, msgs) |
$702 M | 4.34 | 8 |
$39.73 |
Oil and gas pipelines |
| *As of April 9 | | |
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Wall Street has been busy making more MLPs to meet demand by carving them out of larger companies, such as Williams (WMB, news, msgs) and Valero Energy (VLO, news, msgs), and persuading smaller operators to go public. Three new MLPs that appear worth serious consideration are BreitBurn Energy Partners (BBEP, news, msgs), Linn Energy (LINE, news, msgs) and Capital Product Partners (CPLP, news, msgs).
Fine print
To learn more about MLPs, check out the Web site of financial adviser Alerian Capital Management, which specializes in the group. Alerian has produced an excellent primer on the sector; download the PDF here. . . .
To find information on car and gas usage, visit this site. To view a table showing gasoline prices over the past year, visit this Department of Energy site. . . . To learn more about Kayne Anderson's closed-end fund, visit its site. . . . To learn all about the exciting world of natural-gas transportation and processing, visit Copano Energy's Web site. Lots of nice pictures of pipes.
Meet Jon Markman at The Money Show Las Vegas
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At the time of publication, Jon Markman owned shares of Copano Energy and Valero Energy.
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