At this point, the master limited partnership cat is out of the bag.
It’s pretty easy to see how MLPs have caught on, and the asset class is far from a secret anymore. But now, there’s one more way to skin this high-yield cat.
A recent IPO filing by midstream operator Tallgrass Energy Partners LP (NYSE:TEP) highlights an often ignored subsector of the MLP marketplace — one that features faster-growing payouts than their limited partner brethren.
For investors looking for sheer dividend growth, general partners could be where it’s at.
All About IDRs
With investors still craving high-yield equities amid low interest rates, a variety of MLPs have begun spinning off their general partner assets as separately traded stocks. Tallgrass’s filing was the latest in a barrage of general partner IPOs and will hold all of TEP’s incentive distribution rights, TEP’s general partner interest, as well as actual shares of TEP stock.
But what does that exactly mean and how is that a good thing for investors?
A MLP is basically divided into two parts — the limited partner (LP) and general partner (GP). Typically, when you buy shares in a MLP — say, Enterprise Products Partners L.P. (NYSE:EPD) — you are buying the LP side and are purchasing a share of the cash flows and distributions produced by the MLP. These are backed by the pipelines, coal mines, gathering systems or whatever that have been “placed” inside of the LP.
Now, limited partners are just that: limited. People who own the LP don’t actually manage the day-to-day business of the MLP, they just own rights to those cash flows and distributions. That’s why they kick out such huge distributions; LPs are pass-through entities with basically no overhead.
The other side of the equation — the general partners — are actually running the show. They decide what pipelines to buy/drop-down, how to expand, etc. As such, GPs are entitled to receive fees and extra bonuses for managing the MLP, called incentive distribution rights, or IDRs. Most of the time, MLPs will use a system that spells out that if the LP is paying out X cents per quarter, the GP will collect Y% from the top. Additionally, GPs will be the majority owner of the LP units that are publicly traded.
The vast majority of the time, general partners are tucked inside another larger corporation. For example, Spectra Energy Corp. (NYSE:SE) owns a ton of natural gas utility assets as well as the GP of Spectra Energy Partners, LP (NYSE:SEP). In other words, SEP’s general partner is just a part of its overall business mix (a lucrative piece, but just a piece).
Recently, many MLPs have begun spinning off their pure GP ownership as a way to raise cheap capital to grow the overall MLP — great news for investors looking for growing yield. Under a normal IDR tier structure, an MLP that raises its distribution rate by 6% annually will result in a 16% compound growth rate in IDR fees for the GP. Given that compounding — plus ownership of LP shares — GPs’ rate of dividend growth has actually outpaced the corresponding LP shares rate by a wide margin.
While the headline yield isn’t as high — remember, LP shares are pass-through entities — you’re actually banking more dividends over time by owning the GP than the LP.
One ‘Pure’ GP To Own Today
There are several “pure-play” general partners out there to own, but a few are better than others. The one that basically wrote the book on why these things can be huge for your portfolio is Energy Transfer Equity LP (NYSE:ETE).
As one of the largest midstream systems in the U.S., ETE has its hands in many soups — everything from oil storage and natural gas pipelines to even barges. And because it is so big, Energy Transfer Equity collects IDRs and distribution payments from a ton of different MLP arrangements. These include Energy Transfer Partners LP (NYSE:ETP), Regency Energy Partners LP (NYSE:RGP), Sunoco Logistics Partners L.P. (NYSE:SXL) as well as Sunoco LP (NYSE:SUN).
Given just how many, ETE has managed to see consistent dividend growth over the past few years. Its latest bump was an 8.4% increase. The beauty is that even when ETP — its flagship MLP — was struggling, ETE still managed to collect higher cash flows from it.
But ETE isn’t done yet, and recent moves highlight just how powerful a GP is for an investor’s portfolio.
The midstream firm has plans to merge Regency Energy Partners into ETP. That deal will cost ETE nothing, as ETP is doing the buying, but will result in much higher cash flows back into ETE. ETE was only collecting from the second tier at Regency, or about 25% of the cash flows, but it was in the third IDR tier at ETP. Thus, by merging the two, ETE will instantly boost its cash flows and distributions from the newly merged MLP without lifting a finger.
Energy Transfer Equity also has plans to launch a new liquefied natural gas export MLP, from which it also will gain those lucrative IDRs. ETE currently yields 3%.
Bottom Line
While MLPs have been all the rage, investors may want to turn their attention to the other side of the equation and look at general partners. The GPs might not have the headline yield, but you’ll achieve high yield through dividend growth.
ETE is just one example of firms doing it right.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
