by Bryan Perry | August 13, 2014 8:28 amMore mergers and acquisition (M&A) news Monday morning kept the passion burning for many market participants. Kinder Morgan (KMI) is rolling up all of its publicly traded partnerships into shares of KMI to consolidate its operations at a 23% premium to Friday’s closing prices. The deal is certain to provide a boost to the energy MLP sector.
At the same time, however, the month of August is historically the toughest period for the stock market to trade higher. Trading volume is light, which naturally invites a higher level of volatility that can spell trouble.
And volume certainly was light on the way down into this latest dip; technicians would tell you that there could be more to go on heavier volume if the market doesn’t hold its Friday bounce. The S&P may well trade back up to its 50-day moving average at 1950 and then pause and possibly retest 1900 by the end of the month.
If it plays out that way,investors in high-yield dividends will have an excellent buying opportunity to catch some great prices as the market sets up for a post-Labor Day rally into year-end. At this point, the U.S. economy is on very good footing, which bodes well for persistently low interest rates and higher prices for high-yield dividend stocks — such as the three energy plays I’m recommending today.
I’ve mentioned before that one of my favorite energy MLPs is Memorial Production Partners LP (MEMP), and I was very impressed with its second-quarter results.
This oil and gas small-cap rallied strongly after reporting that average daily production increased by 23%, with adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) coming in at $73.8 million, a 32% gain from $55.7 million in the second quarter of 2013. MEMP’s second-quarter cash distribution of $0.55 per unit is 16% higher than the minimum quarterly distribution of $0.47.
In addition, during the quarter, Memorial announced its largest acquisition since its IPO: a $915 million purchase of properties in Wyoming that closed on July 1. The company conducted an 8.6-million-share secondary offering on July 10 at $22.50 per share; today the stock trades about a point below its all-time high of $24.76 set back in late June.
The current yield stands at a very attractive 9.3%, considerably more than you can get from Kinder Morgan or most of the other “big kahunas” in the energy MLP world. Consider buying MEMP on the next dip.
Another energy MLP showing operational prowess is Linn Energy (LINE), which reported quarterly earnings of $0.58 per unit, well above the $0.42 forecast. The beat was attributed to a 2.4% increase in oil and natural gas production. These results do not include any additional revenue and profit from the several transactions conducted during the quarter, laying the groundwork for further upside gains in future quarters.
I had wanted to get involved with this enterprise for some time now, and it’s finally cleared my risk/reward hurdle. The company has been under scrutiny for the past year about its accounting methods. Not to be deterred, Linn acquired Berry Petroleum for $4.9 billion, a move that has been immediately accretive to LINE’s distributable cash flow. The SEC got involved to investigate allegations of financial gimmickry but found the accusations to be without merit, gave a thumbs-up to the deal and gave Linn a clean bill of health on its accounting.
Despite some volatility in the share price, the company has maintained its highly attractive payout that translates to a current yield of 9.1% and is paid monthly. With a market cap of $10.5 billion, and approximately 8 trillion cubic feet equivalents (Tcfe) of proven reserves, there is plenty of room for Linn Energy to foster growth through monetizing the Berry Petroleum deal and making future acquisitions of proven reserves — and there’s an upcoming deal involving an asset swap with ExxonMobil (XOM) on the horizon as well.
That’s a recipe for dependable income going forward.
I’ve made no secret of the fact that energy MLPs are one of my top investment themes — but they’re not ideal for all accounts. I wouldn’t hold any of these K-1 related income assets in your IRA, as the IRS allows for only $1,000 per year in MLP-related income before penalties are applied. Generally speaking, it’s easier to avoid this kind of situation than to have to actively manage those holdings in a retirement account.
That’s why I’m happy to share this next energy pick: LinnCo (LNCO).
As noted on the company’s website, LinnCo was “created to enhance LINN Energy’s ability to raise additional equity capital to execute on its acquisition and growth strategy. LinnCo’s sole purpose is to own LINN units and has no assets or operations other than those related to LNCO’s interest in LINN. As a result, LNCO’s financial condition and results of operations depend entirely upon the performance of LINN.”
The primary difference between the two is tax treatment. Income from LINE is reported on a K-1, but income from LNCO is reported on a year-end 1099 and is taxed as ordinary income. The yield on LNCO shares is a tad higher, currently 9.5% because the shares are trading at a slight discount to shares of LINE. Both stocks are paid the same stated $2.90 annual distribution, just treated differently by the IRS.
The other bonus for income investors is that both LINE and LNCO pay monthly distributions, a very nice feature that more MLPs are adopting to attract investors and smooth out volatility. As investor confidence returns and boosts the LINE share price, a comparable yield of 7%-7.5% to its competitors implies a $38 unit price — or higher if the company hikes the future payout. Shares of LINE are ideal for cash accounts, and shares of LNCO are a great fit for retirement accounts.
All three of the MLPs I’ve recommended today are holding strong at the moment, bolstered by the Kinder Morgan deal — but don’t forget that August is typically a difficult month for equities in general. I suggest you use one of these down days as an opportunity to go discount-shopping for great dividend stocks like MEMP, LINE and LNCO … then look to ride the wave higher on the next rally.
Bryan Perry is the editor of Cash Machine, a newsletter focused on high-yield income investing with the goal of maintaining a blended total yield of 10% across two portfolios. Bryan is also the editor of Extreme Income, which uses the power of historically cheap money to create a leveraged “baby hedge fund” strategy that paves the way to massive profits and up to 4x greater income.
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