Despite the Federal Reserve’s promise not to taper, it will eventually stop its bond-buying program and raise interest rates. And this prospect of higher rates has sent many high-yielding and income-oriented investments down the tubes in the past few months.
That has included my favorite energy income stomping ground: master limited partnerships, or MLPs.
However, investors shouldn’t abandon their MLP holdings just yet. In fact, they might want to add to their exposures.
According to a new report from research group Ned Davis, several of these pipeline and gathering firms are actually great bets during a period of rising interest rates. The reason is their history of aggressive distribution growth and high distribution coverage ratios — essentially, the cash that an MLP has to cover their current payout as well as future ones. Firms with higher coverage ratios have historically been able to provide yield growth in excess of rising rates. And considering that most MLP yields are already way higher than Treasury payouts, investors can reap major income from holding these partnerships.
In fact, Ned Davis estimates that “MLPs with strong distribution growth over the next 12 months should outperform other MLPs by 15% per year,” according to Barron’s.
So who exactly makes the cut? Here are Ned Davis’ top five ideas — yielding up to 7% — for investors looking for MLPs to fight off rising interest rates.
Magellan Midstream Partners
Dividend Yield: 3.7%
While most pipeline and midstream firms have been adding natural gas exposure to take advantage of rising production in the U.S., Magellan Midstream Partners (MMP) has taken a more “oily” approach and focuses pretty much exclusively on crude oil assets. The MLP’s 9,600 miles worth of pipelines and 80 million barrels worth of storage represent the longest network of refined petroleum capacity products in the country.
Taken another way, MMP’s midstream network can tap into more than 40% of the nation’s total refining capacity. That’s a pretty big deal.
This dominance has allowed Magellan to continually grow its distribution and cash flows in a variety of market conditions — including rising interest rates. For the latest quarter, Magellan reported a 40.1% year-over-year increase to its distributable cash flow. Not surprisingly, MMP also upped its payout for the third quarter by 5% to sit at 55.75 cents, or $2.23 annualized. So far this year, Magellan has raised its distribution by 15%.
Perhaps more importantly, MMP management estimates it will be able to increase the distribution by at least that much in 2014 … making this MLP a perfect way to beat rising interest rates.
Sunoco Logistics Partners
Dividend Yield: 3.7%
While its former parent Sunoco no longer exists as a standalone company nor as a refiner, Sunoco Logistics Partners (SXL) continues to churn out steady and rising distributions for its shareholders.
Its key crude oil positions in places like Texas and Oklahoma as well as its refined products and NGLs lines in the Northeast, have helped SXL raise its distribution for 34 consecutive quarters. The latest was a 5% increase over the second quarter 2013 cash distribution to sit at 63 cents per share.
And like the other MLPs on this list, Sunoco isn’t resting on its laurels. The midstream firm has embarked on series of projects and moves designed to reduce the impact of declining profits due to its former parents exit from refining. That includes expansion plans in the Granite Wash, Permian Basin and new pipelines in the Eaglebine.
For investors, stable cash flows from those new midstream assets should help SXL continue with its pace of quarterly distribution increases.
Access Midstream Partners
Dividend Yield: 4.1%
While you can debate whether beaten-down natural gas producer Chesapeake (CHK) is a buy or just junk, its former MLP subsidiary Access Midstream Partners (ACMP) is very much in the “buy, buy, buy!” camp.
The MLP’s asset base — all 6,700 miles worth of pipelines — is right in the heart of America’s natural gas revolution. That includes exposure to all the big boys like the Marcellus, Utica, Haynesville and Barnett shales. More importantly, it continues to add new gathering lines and processing plants in these regions to take advantage of all the new drilling activity going on. That first mover status will help it continue to increase cash flows and dividends going forward.
Not that Access really needs them. Since its first distribution in 2010, ACMP has managed to double its payout for unitholders. The latest bump was a huge 23% increase vs. the third quarter of 2012 or a 10% sequential increase. That bump has ACMP units yielding a delicious 4.1%
And given Access’s focus on growth, those payouts should rise even more in the future.
Plains All American Pipeline
Dividend Yield: 4.8%
As one of the largest MLPs in terms of their total midstream asset size — handling around 3.5 million barrels per day worth of crude oil and natural gas liquids (NGLs) — Plains All American Pipeline (PAA) has been a champion for portfolios for years.
Just how much of a champion? Since going public back in 1998, PAA has managed to raise its distribution by a whopping 167% to its current $2.40 per unit on an annualized basis.
And more could be in store. PAA has just agreed to swallow its former natural gas storage spinoff PAA Natural Gas Storage (PNG) in a $1.41 billion deal that will instantly be accretive to PAA shareholders. Meanwhile, Plains continues to build new capacity and crude-by-rail services in key refining markets like California.
All in all, that should help PAA reach management’s goal of boosting the distribution by 10% by November 2014.
Dividend Yield: 7%
When it comes to natural gas, Williams Partners (WPZ) is simply one of the biggest players. The firm is one of the leading midstream players in the prolific Marcellus shale. That dominance has WPZ’s network of pipelines carrying roughly 14% of all the natural gas consumed in the U.S.
So it’s no surprise that WPZ has been a cash flow and distribution king for investors.
Williams’ payout has increased every quarter since May 2010, and the latest bump was an 8.7% year-over-year increase. With management adding new capacity in the underserved Marcellus and Utica shales for both natural gas and NGLs, analysts remain confident that WPZ should see distribution growth in the new year that will beat rising interest rates.
Shares of WPZ currently yield a hefty 7%.
As of this writing, Aaron Levitt was long MMP.