For investors looking to cash in on America’s energy renaissance, there is one special class of investments. Over the last 10 years, a select group of stocks has beaten the S&P 500 index by a factor of 2-to-1.
These investments are known as Master Limited Partnerships or MLPs. Most MLPs are in the business of collecting, processing, refining and transporting oil and natural gas. Many of my favorites are in the business of operating vast networks of pipelines that are used to transport America’s growing energy production.
MLPs and the Tax Reform Act of 1986
What makes MLPs special is that they’re legally able to avoid paying income taxes. That’s because in 1986 President Ronald Reagan signed a tax reform law that encouraged investment in domestic energy. By allowing a select group of energy infrastructure companies to operate tax-free, he aimed to encourage much-needed capital investment.
Thanks to technological developments including fracking, America is well on its way to achieving energy independence by 2030. And in just four years, the U.S. could eclipse Saudi Arabia as the world’s top oil-producing country. Even President Reagan would be impressed by the massive growth that his tax reform encouraged.
America’s energy boom stretches from the Marcellus Shale in upstate New York to the Eagle Ford Shale in Texas. With oil production expected to grow by 50% over the next six years, there will continue to be many profit opportunities.
MLP performance – measured by the JPMorgan Alerian MLP Index (NYSE: AMJ) -lagged the S&P 500 (NYSE: SPY) by about 4% last year. But with a strong long-term track record, select MLPs could continue to deliver superior returns in 2014.
My favorite MLPs share three common traits. First, they are investing in their business and growing. Second, they are increasing their cash flow and dividend payments to shareholders. And third, their cash flow is more than enough to cover the dividend payments.
I’ll share two MLP investment ideas that meet these criteria. In fact, I recently bought both stocks in my personal investment account.
My first MLP recommendation is MarkWest Energy Partners (NYSE: MWE). The company was a first mover in the Marcellus Shale, and is also active in the rapidly growing Utica formation.
MarkWest pays a 4.7% dividend yield and increased its dividend payments in each of the last four years. Despite a slight earnings miss earlier this week, MarkWest has plenty of cash flow to pay higher dividends in 2014. I think it’s possible for the dividend to grow 10% – 13% this year.
My second MLP recommendation is Plains All American Pipeline (NYSE: PAA). With more than 17,400 miles of oil and gas pipelines and a $20 billion market cap, Plains All American is a major player.
Similar to MarkWest, Plains All American Pipeline pays a 4.6% yield. Based on the company’s growth prospects, it looks as though Plains All American will grow its dividend by about 10% in 2014.
One of the best reasons to own these MLPs is because they’re raising their dividends. Over time, the share price of a dividend stock tends to move in tandem with the dividend. And this means that a company that consistently raises its dividend by 10% should see its share price rise by about 10% per year.
Both MarkWest and Plains All American Pipeline are likely to grow their dividends by 10% or more in 2014. Assuming that the share price follows suit, I think it’s possible that both of these stocks will deliver 15% – 20% total returns in the next year.
What is your favorite MLP? Do you own shares of MarkWest or Plains All American? I would love to hear from you. Please send me an email at [email protected]
I’ll be writing more about MLPs in the coming weeks. If you send me the names of your MLPs, I’ll be evaluating additional stocks in an upcoming edition of Income & Prosperity.
Income From Pipelines: the Safest Energy Investment
Most investors hope to “catch a flier” on small, risky exploration companies who usually don’t have a drop of oil in their wells. But in our experience, people don’t build pipelines until they know when and how much oil they’ll pump. Which makes pipeline stocks the least risky investments in the entire energy sector. No pipes – no oil. Click here to read my full write-up on two American pipeline stocks paying big (and growing) dividends.