by Aaron Levitt | October 19, 2012 6:30 am
As the Federal Reserve sticks with its zero interest rate policies in hopes of jump-starting the economy, investors looking for income have become accustomed to adding some alternative assets — such as preferred stocks or closed-end funds — to their portfolios.
Another asset class has that has gained in popularity among yield hunters is units in firms that own the various pieces of energy infrastructure that crisscross our nation. Featuring high, tax-advantaged distributions, these pipeline master limited partnerships (MLPs) have seen a surge of investor interest over the last few years.
MLPs have been further boosted by the sheer abundance of energy trapped beneath North America’s shale formations. After all, gathering and moving all of that energy to end users is a key ingredient in for America’s future energy independence. It’s also a pretty stable and profitable business to be in — as some of recent earnings announcements show.
If you’re looking to add some yield from the oil patch, the bigger pipeline and gathering system MLPs could be exactly what you need.
Across the country, pipelines, petroleum storage tanks and switching terminals help move traditional and unconventional energy from the wellhead to processing facilities. Big dollars can be made in supplying and owning that infrastructure — especially for firms using an obscure piece of the tax code from 1986.
To stimulate construction of domestic energy infrastructure, the changes in 1986 allowed for pipeline firms to be structured as partnerships. This allows the income that MLPs distribute to avoid the double taxation that corporate dividends suffer. Dividends that are paid out of earnings get taxed twice — once at the corporate level, then again as a taxable gain to shareholders.
Perhaps more important, MLPs feature a further break, in which taxes on 80% of the distributions are deferred until investors sell their partnership shares. All in all, these tax breaks result in some pretty big dividends for investors — called unit holders in the MLP world.
Funding those distributions is made possible by the stable nature of the pipeline industry. Functioning like a tollbooth, these companies’ profits are based on the volume of oil or gas that flows through their pipes, not on what that the liquid is worth. So, fluctuations in price — such as from geopolitical conflict — have zero effect on their bottom lines.
Many also come with regulated fee amounts with inflation adjustments, as well as “take or pay” contracts, which require users to pay regardless of whether the pipeline capacity is used. This allows investors to profit from the long-term trend of increasing energy demand, while providing a backstop against price swings.
MLPs are great total-return performers as well. Over the last 10 years, MLPs — as represented by the sector’s benchmark Alerian MLP index — generated an average annual total return of 16.7%. That’s roughly about twice that of the S&P 500.
Given the tax benefits and total-return aspects of MLP ownership, investors may want to give the sector a go. Some of the best cash flows and consistent earnings can be found in some of the largest and oldest pipeline players. Here’s a rundown of the sector’s major names — and three top bets among the MLPs.
Serving as the benchmark, Kinder Morgan Partners (NYSE:KMP) is one of the largest publicly traded MLPs in North America. It features assets across a wide range of energy infrastructure, giving you exposure to natural gas, oil, natural gas liquids (NGLs) and other refined products pipelines and terminal facilities. That diversification has enabled the partnership to dilute its business risks and create an overall stable company.
That stability allowed KMP to report higher profits for the third quarter. Net income rose to $379 million vs. $215 million in the same quarter a year earlier, a gain of 31.6%. More important, the partnership’s cash distribution was raised to $1.26. KMP has now hiked the quarterly distribution 45 times since 1997. That payout boost was fueled by the sale of 100% of Tennessee Gas Pipeline and 50% of El Paso Natural Gas by parent Kinder Morgan (NYSE:KMI). Units of KMP currently yield 5.87%.
Almost equal to Kinder Morgan in size, Enterprise Products Partners (NYSE:EPD) features a vast array of pipelines, processing plants and gathering systems in some critical production areas like the Eagle Ford.
However, the firm benefits not only from its existing pipeline network but also from being one of the most aggressive MLPs in adding new capacity. Enterprise recently opened its 350,000-barrel per day (bpd) Phase I Eagle Ford oil pipeline, and it reversed the flow of the critical Seaway pipeline with partner Enbridge (NYSE:ENB). Enterprise has several projects under construction in America’s shale, such as the 1,230-mile Appalachia-to-Texas Express Pipeline and the 436-mile Front Range pipeline.
All of these will help boost its distribution, which Enterprise has managed to do over the last 16 years. It yields 4.8%.
While not as diverse as KMP and EPD, ONEOK Partners (NYSE:OKS) is still an MLP elder statesmen and is one of the few with a market cap greater than $10 billion. It primarily operates with natural gas and NGLs throughout the central U.S. and Rocky Mountain regions.
However, like EPD, it has begun to expand its assets in the oil-rich Bakken shale of North Dakota and currently has about $6 billion worth of growth projects underway. This includes a massive $1.2 billion crude oil pipeline expansion running from the Bakken to “the pipeline crossroads of the world” — Cushing, Okla. Overall, OKS is one of the major players in the region for both the gathering and processing of natural gas and the transportation of crude oil.
More important, growth in the Bakken will help fuel the firm’s projected distribution increases of 10% to 15% per year through 2015. ONEOK currently yields 4.4%.
Overall, the pipeline MLPs offer income investors plenty to cheer about, and the trio of KMP, EPD and OKS could be some of the best of the best.
As of this writing, Aaron Levitt didn’t own any securities mentioned here.
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