Every time I think I know about every type of investment the market has to offer, some smart aleck comes along and says, “Yeah? Did you hear about this one?” In this case, it was my editor, who suggested I take a long hard look at master limited partnerships, or MLPs. He was right, of course. Editors are always right.
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.
There are 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. 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.
So what are the best candidates for your portfolio? The sector as a whole averages about an 8% annual yield, so I like to look for investments within 200 basis points of that average. It’s always a good idea to diversify, so the ALPS Alerian MLP ETF (AMEX:AMLP) is a good choice. It yields 6.36% and is a bit more expensive, with an expense ratio of 0.85%, but I prefer the diversity it provides over the other ETF/ETNs out there.
A more conservative 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 6.1%. It is also experiencing 25% to 30% earnings growth, and has very manageable debt service (5% interest).
If you want to roll the dice, then Cheniere Energy Partners (AMEX:CQP) is for you, with its 11.2% yield. The dividend payment has been stable, but the company is struggling under expensive debt service. When coupled with weakening revenue, Cheniere Energy has been showing small quarterly losses. It could go either way, but that’s why you get an 11% yield while the situation resolves itself.
In the middle of the pack, have a look at Energy Transfer Partners (NYSE:ETP), currently yielding 8.1%. Energy Transfer had a couple of burps in its payouts in 2010, but those were very much the exception. NuStar Energy (NYSE:NS) yields a stable 8% and has increased its dividend consistently over the years. Finally, Boardwalk Pipeline Partners (NYSE:BWP) pays out 7.45% and also has been both stable and consistently increasing over the years.
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.
As of this writing, Lawrence Meyers did not own a position in any of the aforementioned stocks.