Pipelines to profit: Investing in high-yielding Master Limited Partnerships

Master Limited Partnerships (MLPs) are high yielding exchange-traded instruments. As partnerships, they must return all earnings to the partners each year, resulting in a much bigger pay out than most dividend bearing stocks. The yields are called “distributions” not “dividends” and instead of owning “shares” you own “units.” To become a partner you simply purchase units like any other stock through your discount broker (it makes no sense for the average investor to use anything but a discount broker).

To qualify as a MLP under IRS rules, a business must earn 90% of its income from dividends, interest, real estate or natural resources. The majority of MLPs are in the energy business, with most operating natural gas pipelines. Some of which engage in “midstream services” including gathering, pumping, compressing, and refining petroleum or natural gas, and the separation of natural gas into Natural Gas Liquids, such as propane.

After construction is complete, except for occasional repairs or nominal maintenance costs, operating expenses are minimal. Because pipelines are storage and transportation services, they are profitable regardless of fluctuating commodity prices. Consistent need for energy also means pipelines are a recession-resistant investment, providing a consistent stream of income, year in and out, just like utility companies. In fact, rating agencies value pipelines like fixed income investments. But pipelines have several advantages over fixed income products and utilities, including tax deferred status, potential for growth and increasing yields.

This is not to imply pipelines are risk free. Pipelines are expensive to build. High interest rates can cause delays or loss of profits. And although commodity prices rarely affect MLPs that are primarily involved in storage and transportation, some of them can be affected by market risk associated with fluctuating commodity prices. Oil wells and gas fields have a limited capacity, and when the well or field runs dry, so can the value of the investment. To grow, these businesses must build additional pipelines and make new acquisitions

So how does one know which are good investments? Excessively high yield is often a red flag. Is the company, for example, paying out over 100%? If so, that is obviously not sustainable, and could indicate a distribution cut is on the horizon. I believe in fundamental over technical analysis, but I find financial reports difficult to understand, am not good with numbers and can’t do the analysis myself. But I don’t need to. Professional analysts already rate these companies, so I subscribe to trustworthy newsletters and use their recommendations as a starting point.

Next I compare the opinions of the analysts on brokers’ web sites, each broker usually offering several. It’s not necessary to understand everything. What I look at is if there is general agreement on the quality of the stock, as well as the reasons given for any negative recommendations. In examining the annual report, I pay particular attention to what the report says about capacity of proven reserves, as well as new acquisitions.

Looking at recent news related to the stock can be also be helpful. There is usually a link to such information on the Internet along with the company profile, either on brokers’ web sites or on an Internet site such as Yahoo Finance. When reading about investments it is important to distinguish between factual information versus hype about future projections. This is especially important not only in considering what investments to make, but in considering which newsletters to trust, as well in evaluating the advice. Evaluating investment newsletters though, is a separate topic which I hope to address in a future post…

Some Master Limited Partnerships I like:

UPDATE:  I practice socially responsible investing. As long as most energy generated comes from fossil fuels natural gas has the lowest impact in terms of  both air pollution and carbon footprint. However, as information accumulates it seems clear the new fracking technology used to drill for natural gas poses a serious threat to our water. Under the circumstances I no longer recommend investing in companies that engage in drilling for natural gas.

Furthermore,  the recommendations stated below were made in August of 2009. As I update this entry I note that presently the stock price has increased significantly from the date when the recommendations were made. These particular investments no longer pay the high yields they did when the recommendations were made.  The increased cost of purchasing these companies at today’s prices makes them far less profitable to buy today. Stated simply, even if I were not concerned about the environmental dangers  I would not recommend these stocks at the present higher prices and lower yields, because they simply are not as profitable if you buy them at today’s prices than they were on at the time I originally recommended them. Remember all investing advice is time sensitive in that things change.

Enterprise Products Partners (EPD) currently yielding 7.9% (has growth potential).

Mark West Energy (MWE) currently yielding 12.1% (exposure to greater profits if commodity prices increase).

Terra Nitrogen (TNH) currently yielding 8.2%  (non-energy pipeline transporting liquid fertilizer to agricultural communities). It’s a good one, but I suggest buying at $102 or less.

Two non-pipeline MLPs that are like utilities:

Amerigas (APU) currently yielding 9.6%, is a buy up to $34.

Suburban Propane (SPH) currently yielding 8.1%, was recently recommended in a newsletter that has always made me money.

NOTE: “currently yielding” refers to the date I wrote this entry. Yields change with market price of the stock, you can check yield at the time of purchase.

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