There is little doubt that the U.S. energy boom has created great opportunities for both growth and income investors.
One doesn’t have to look far to find a stock that has outperformed the S&P 500 by tapping into newfound oil and gas reserves. One group – Master Limited Partnerships (MLP) – has been particularly lucrative for investors.
We don’t typically see these types of companies growing as quickly as they have in recent years. But the rampant growth of oil and natural gas production has MLPs firing on all cylinders.
Uncovering Great MLP Investments
For instance, over the last three years, Kinder Morgan Energy Partners LP (NYSE: KMP), one of the largest pipeline transportation and storage MLPs in the country, has grown revenue and EPS at average annual rates of 15.8% and 36%, respectively.
By both measures KMP is growing at least twice as fast as it did over the last decade.
And that rapid growth is fueling higher distributions, which investors have been more than happy to receive. Over the last three years KMP’s quarterly dividend has increased by 21%.
KMP’s return over the last three years has been decent, handing investors 36% (including dividends and capital gains). But that’s actually a low return in the MLP sector; the broader JPMorgan Alerian MLP Index (NYSE: AMJ) has done much better, delivering a total return of 67%.
That’s a full 14% greater return than the S&P 500, which by all accounts, has had a phenomenal three-year stretch as well.
Aside from the fact that MLPs are operating in an extremely favorable environment right now, with high oil and gas production growth and low interest rates, there are a few qualities of the organizational structure that is allowing them to grow distributions (dividend payments) quickly too. And this is helping to drive their unit prices higher as investors will pay more to grab yield.
MLPs prefer that more money flows to investors, not to the government. So they’ve organized their businesses to avoid all corporate income taxes. They do this by forming partnerships instead of corporations.
The rules to form as an MLP are simple: The business must derive 90% of its income from what the IRS labels “qualified” sources. Basically, this means sticking to the production, processing and transportation of oil, natural gas and coal.
From an investor’s perspective, MLP investments are little different than investing in a regular corporation. MLP securities, known as “units,” trade just like normal shares on the major stock exchanges.
MLPs offer a couple of distinct advantages over corporations, though, particularly with regard to management incentive.
An MLP, as its name implies, is a true partnership. The distinction matters, because an MLP has two classes of partners – the general partners who are responsible for running the MLP and the limited partners (you and I) who purchase the units on the major stock exchanges.
The MLP structure incentivizes the general partners to increase distributions to the limited partners. Why? The higher the quarterly distributions paid to limited partners, the higher the management fees paid to the general partners.
Therefore, general partners are motivated to maximize distributions by pursuing cash-generating acquisitions and organic-growth projects. If the general partners enrich you, they enrich themselves.
On Thursday, I’ll discuss an interesting development with one MLP in particular that has just announced an acquisition that should drive higher distributions to shareholders. The deal is getting mixed reviews – but I’ll save that story for Thursday.
In the meantime, check out the performance of the AMJ and consider if MLP investments are right for your “growth” portfolio.
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