The High Yield Safety Net: MLPs

The world will always need energy infrastructure.
Until a few years ago, many income investors stayed away from things that sounded exotic like, “Master Limited Partnerships.” The truth is these are nothing more than regular businesses structured in a different manner that allowed regular investors to buy pieces of them.
mlpsYou basically become part of a partnership that you can buy and sell at will.  These MLPs almost always are in the energy infrastructure sector.
These partnerships were created by Congress in 1987 to spur investment in the energy sector, but only for companies engaged in “the exploration, production, mining, processing, refining, marketing or transportation of mineral and natural resources.”
What’s notable about these investments is that their success is tied to demand as opposed to the underlying price of the given commodity, so they experience much less volatility than, say, oil prices, which makes their cash distribution payments more reliable. In addition, there always will be demand for energy, no matter what happens to the world economy.
Because there will always be demand for energy, there will always be demand for energy infrastructure.

The two risks to MLPs.

The first is that they constantly require capital to keep growing, and if credit tightens again or the secondary market weakens, MLPs with the weakest cash position might not survive. So be careful about MLPs that have tons of debt, little cash flow and little cash on hand.
The second is less serious — namely, a run on mutual funds that hold MLPs, forcing management to sell the stocks. The good news is that after the panic subsides, investors often rush back in to income investments like these.
As for the income investor, the sector as a whole averages about an 8% annual yield.  That’s a high yield and one that is likely to remain high.
The big name in the sector, and your safest bet, is Kinder Morgan Energy Partners (NYSE:KMP). The company’s dividend history has been stable and predictable, even increasing over time, with negligible impact during the financial crisis. It has a current yield of 6.9%. It is also experiencing 10% annualized earnings growth.
Cheniere Energy Partners (NYSE:CQP) is a riskier play. It was struggling in recent years, and has drawn down a ton of debt to expand its operations.  The market seems to have patience and optimism for the company, as the stock has doubled over the past three years.
The yield is 5.2%, and if you want a high-risk, high-reard play, this is for you.
In the middle of the pack, have a look at Energy Transfer Partners (NYSE:ETP) currently yielding 6.6%. Energy Transfer had a couple of burps in its payouts in 2010, but those were very much the exception.
Boardwalk Pipeline Partners (NYSE:BWP) pays out 2.3% and has terrific free cash flow.  I think it has room to increase that dividend.
It’s always a good idea to diversify, so if an individual stock isn’t for you, the ALPS Alerian MLP ETF (NYSE:AMLP) is a good choice. It yields 5.96% and has a number of holdings, of which Kinder Morgan is the top one, representing about 10% of the ETF.

A quick note about taxes.

MLPs must issue Schedule K-1 tax documents every year, and even if you sell an MLP stock at a loss, you might get dinged when your K-1 arrives and it shows income allocated to your shares, even if you never actually received any.
Also, dividends paid by MLPs into retirement accounts are taxable, so check with your tax adviser before placing MLP investments in your retirement account.
Lawrence Meyers does not own shares in any company mentioned.

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