For those seeking income in our zero interest rate world, master limited partnerships (MLPs) have been all the rage with investors. Big money can be made in owning the critical infrastructure required to bring energy from wellheads to end users. Even more can be made if all those pipelines, storage tanks and gathering systems are placed in an MLP because of a tax structure that provides big benefits for individual investors and the sponsoring firms alike.
Strong stable cash flows and high tax-deferred distributions — in the 5% to 8% range — await investors who take the MLP plunge. Given this asset class’s propensity to throw off those big dividends in good times and bad, it’s no wonder why pipelines are popping up in more portfolios.
The big question is: Can MLPs keep up with that outperformance in the new year and beyond?
The answer is a resounding yes. Indeed, MLPs could be the most powerful one-two punch of 2013.
Big Dividends and Price Appreciation
That’s because they’re poised to provide not only big dividends but some pretty nice price appreciation as well.
The dividend aspect is easy to see.
Designed as “pass-through entities” — similar to real estate investment trusts — MLPs by definition are required to pay their unitholders large distributions. These distributions are built on the back of the sector’s stable operating environment. Unlike the exploration and production (E&P) companies that go in search of and then extract energy resources, the infrastructure and pipeline companies’ profits are based on the volume of oil or gas that flows through their pipes — not on what that liquid is worth.
Many come with regulated fees that include inflation adjustments, as well as “take or pay” contracts, which require the various firms using the MLPs’ midstream infrastructure to pay regardless of whether they use the capacity.
All in all, that produces clockwork-like cash flows, the bulk of which the MLPs pass through to investors. The sector’s projected average yield is a juicy 6.5%.
But high, stable dividends are only part of the equation. The normally sleepy sector is undergoing a major growth transformation as well.
By now, we’re all familiar with North America’s energy resurgence, as hydraulic fracturing and unconventional resources are quickly becoming the norm. Drilling activity continues to increase as the E&P industry moves to take advantage of the energy abundance trapped beneath various rock formations across the region.
The problem lies in gathering and moving all of that energy to end users. Give or take, North America has roughly 328,000 miles of natural gas transmission and gathering pipelines. However, that isn’t enough to tap the new energy potential. A study by ICF International shows that the U.S. and Canada will require annual average midstream natural gas investment of around $8.2 billion from 2011 to 2035, or $205.2 billion in total. This equates to around 1,400 miles of new pipeline each year.
According to two prominent investment banks, 2013 will see a major boost in capital spending spending by the midstream sector — to the tune of $30 billion to $33 billion dollars. Both Deutsche Bank (NYSE:DB) and Credit Suisse (NYSE:CS) estimate that 2013 could be one of the biggest years yet in terms of pipeline and midstream construction in the U.S. and Canada.
Already, regulators have OK’d new projects across key producing regions such as the Marcellus and Bakken. Overall, these new construction projects — and the potential for them to increase those juicy MLP dividends — will help the midstream sector realize a 7% gain in unit prices on top of the 6% to 6.5% dividend yield.
Given the uncertainty nearly everywhere these days, getting a double-digit total return is a pretty good deal for investors.
Bets in the Midstream Sector
Deutsche Bank currently has buy ratings on plenty of top-notch MLPs, including Access Midstream Partners (NASDAQ:ACMP), Buckeye Partners (NYSE:BPL) and Western Gas Partners (NYSE:WES). We’ve highlighted plenty of the great individual choices here at InvestorPlace as well.
However, one of better ways to get a foothold in the sector could be through one of the broad exchange-traded products that track it.
The two biggest MLP indexes — the Alerian and Cushing 30 MLP — have put in strong performances already in 2013. The pair has gained 7% and 6.6%, respectively, in the first week of new year. The Alerian index can be played via a number of funds, including the ALPS Alerian MLP ETF (NASDAQ:AMLP) and the immensely popular JPMorgan Alerian MLP Index ETN (NYSE:AMJ). The Cushing index can be had in the Credit Suisse Cushing 30 MLP Index ETN (NASDAQ:MLPN). These funds can provide both the oomph of growth and the big distributions MLPs are known for.
That could give investors a very happy new year, indeed.
As of this writing, Aaron Levitt didn’t own any securities mentioned here.