Recommendation: Buy Amerigas Partners LP (NYSE:APU) on a break above resistance at $45 per share.
Options Alternative: Some traders may also wish to sell covered calls against the position in between dividend payments to further smooth returns.
High dividend paying sectors like utilities tend to do well when stocks are starting to flatten out— partially because they have low volatility in their business models and partially because they pay income. Unfortunately, utilities might be the only place some traders look for new entries when stocks get choppy.
Look to MLPs like Amerigas Partners (APU) in a Downturn
However, there is another class of stock that can be superior in these market conditions called Master Limited Partnerships (MLPs). These are similar in many respects to unit investment trusts like REITs. However, instead of investing in real estate, most MLPs are involved in the transportation and processing of energy commodities like oil, natural gas and propane.
We like Amerigas Partners LP in the MLP category. This portable propane gas and equipment stock has paid a reliable dividend yield of nearly 8% for several years. Investors may initially have some concerns about MLPs right now because they have been lagging the market since early 2011. However, they aren’t accounting for the fact that this is normal.
MLPs must pay 90% or more of their net income to their shareholders. That means that analysis of these instruments will be a little different than it would be with a regular company. Everything from depreciation, to EPS and the balance sheet has to be evaluated based on a different set of criteria than you might use for Apple (NASDAQ:AAPL) or Wal-Mart (NYSE:WMT).
Turnaround in Sight for MLPs
Click to Enlarge MLPs and other defensive or income generating assets tend to underperform when risk assets are doing well and then rotate into favor when growth starts to ebb. Despite Tuesday’s new highs on the Dow and S&P 500, we still feel strongly that growth expectations in the near term are low and investors will be turning their attention to income and safety.
APU is nicely positioned to benefit from that shift and has already been showing a significant level of relative strength compared to its peers and the broad market.
However, pitting an MLP’s performance against the S&P gives an incomplete picture. MLPs don’t retain earnings like a regular company does; they return it to shareholders. Those dividends have to be included in order to make a fair comparison. In the second chart at right you can see the total return (including dividends) of APU and the S&P 500 SPDR (NYSE:SPY) over the last few years.
Click to Enlarge The chart assumes a long-term holding period for dividends paid by APU to smooth returns and amplify performance. It seems reasonable to assume that APU will outperform the S&P 500 in the short term if the market flattens a little. However, investors usually consider timing an entry into high-income producers and defensive stocks when they are rebalancing and considering a longer term position.
Amerigas Prospects in 2013
Like many companies, APU has seen declines in business due to the recession and the slow housing recovery. However, housing trends fundamentally shifted in APU’s favor in 2012 with the first uptick in propane-heated homes since 2005. Additionally, APU acquired the propane operations of Energy Transfer Partners (NYSE:ETP) in 2012, which should lower costs and increase the potential customer base in 2013. Those benefits have not been fully priced into the stock due to competition from risk assets in higher growth sectors.
Currently, APU is breaking out and looks likely to meet their 2013 goals of increasing EBITDA by over 50% in 2013. The company has added leverage as part of their 2011-2012 acquisition but it should put them in a much stronger position to grow with the housing market in 2013-2014. This should drive the dividend in absolute terms and the stock’s price over the next 18-24 months.
We like an entry on a breakout above $45 per share. That is still technically within the current long-term consolidation but is above near-term resistance and should confirm momentum. Unlike many of our past trades, the timing is all about getting into the trade while it is undervalued for the long-term rather than a short term hold.
Trading options on MLPs like this is tricky. For example, puts will be overpriced because the put holder receives the theoretical advantage of the drop in price when the stock pays a dividend. It also sometimes looks like calls are underpriced for the same reason. This phenomenon catches even very experienced option traders off-guard sometimes.
However selling calls against the long position in between dividend ex-dates could be a very effective way to reduce volatility.
Note about MLP dividends: Although the dividend is attractive, MLP dividends are ‘unqualified’ which means they are not generally taxed at a capital gains rate. Talk to a qualified tax advisor if you have questions about holding an MLP in a tax sheltered account and its impact on your overall tax situation.
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.