INTRODUCTION: THE BUY OF THE DECADE?
In our last blog we discussed one of the best Energy Infrastructure Master Limited Partnerships (MLPs), Enterprise Product Partners (NYSE:EPD). In sum, it has a high and reliable dividend that is growing even in this market.
In this blog we step back to present a brief overview of what makes the Energy Infrastructure MLPs arguably among the best sectors for those seeking high dividend stocks with the solid business fundamentals to sustain and grow those dividends.
For relatively low risk and very high dividends, there is arguably no better sector.
With the fear-driven flight to quality pounding US Treasury paper yields to all time lows, (10 year bond at about 2.5%, 3 month near zero) income investors without multimillion dollar portfolios have no choice but to seek higher yields or consume their principle.
The good news is that once-in-a-generation fear levels produce equally rare opportunities as quality stocks get thrown out with the rest. Among the very best available are the energy infrastructure Master Limited Partnerships (MLPs). Even the best of this group have been far oversold based on their very solid fundamentals, and thus offer historically high yields for such strong businesses. How oversold? Historically the best of this group offered about 2% higher yield than ten year treasuries. They currently offer over 8.5% higher yields – over 11%.
In our last blog we discussed one of these, Enterprise Products Partners. Before reviewing others among our favorites, let’s look at the group as a whole.
A. HERE’S WHAT MAKES THEM SO ATTRACTIVE.
In essence, a unique combination of high, reliable dividends backed by sound businesses with almost utility-like market positions.
1. Stable and growing dividends averaging over 11% even under current conditions
The Law requires these MLPs to pay unit holders (the technical term for stockholders in MLPs) almost all of their cash after meeting ongoing operating, debt, and capital project obligations. Our MLPs have low payout ratios that can easily cover distributions under current and even worse conditions. Some will even continue to increase them (like EPD did in November), though perhaps at a slower pace. Given the extreme regulatory and political difficulties of building new pipelines and storage facilities, these companies have utility-like monopolies on critical oil and gas transport and storage. Thus regardless of market conditions you collect extremely high, reliable dividends.
2. Declining energy prices and reduced access to outside capital limits capital asset growth, but not distributions
Revenues are mostly based on the volume, not price, of oil or gas moved through their pipeline and storage systems. So they have limited-to-zero direct commodity price exposure. Weak demand may reduce that volume and ultimately may limit expansion projects that feed future revenue growth. However, ongoing operations and dividend distributions are safely covered even with reduced revenue. Volume may not even suffer significantly, as weak demand drives down price more than volume.
3. Better Transparency Than Bonds
As with any stock listed on a major exchange, information on price trends, charts, bid/ask spread and other data needed for sound investing decisions is far more available than with bonds.
HERE’S WHY THEY’RE BEATEN DOWN
With such healthy fundamentals and seductive dividends, why the relatively low prices and high yields? Major reasons include:
A. Indiscriminate panic selling
From investors of all sizes, the motive has essentially been the same. Excessive fear.
B. Confusion about how the MLPs make money
Many mistakenly assume these companies are deeply affected by declining energy prices, or that limited access to outside capital endangers current distributions. As noted below, this mistaken linking of these MLPs to energy prices brings an additional opportunity besides great valuations.
C. Market risk
This is a legitimate concern for those possibly needing cash invested in these MLPs within the next few years. Almost all stocks, these included, follow the overall market, which most believe (and our research concurs) is very likely to drop further before bottoming. The next sustained bull market and chance of price appreciation or recovery may well be years away.
Thus we continually remind readers that new income stock buys should be only with funds if they will not be needed for as long as the next 3-5 years. But with average yields over 11%, you are well compensated for your patience and stand an excellent chance of long term appreciation.
D. The Islamic - Russian Wildcard Bonus?
Here’s a possible additional bonus. At these low prices, there is also a very real chance for near term appreciation from news-driven speculation. These stocks move with energy prices, which can move violently higher when tensions rise in the Middle East. Given that the West and Israel have yet to show genuine determination to conclusively militarily defeat the forces of radical, imperialist Islam, these tensions will continue to periodically boil over in various forms of terrorism or conflicts, scare world markets and send any energy related stock higher, the MLPs included. Neither Israel’s unilateral cease-fire in Gaza, nor Obama’s rush to close Guantanamo suggest the determination needed to bring about the only likely solution: utter decisive military defeat of radical Islam’s military.
Russia, greatly dependent on energy exports to Europe, has also shown signs of willingness to use aggression to maintain its position as sole provider for much of Europe’s energy needs.
In sum, we have obscenely high, safe income in the top MLPs, as long as one can ride out further possible market declines. Given their utility-like near monopoly in their respective regions, they have historically offered about 2% higher yield than the ten year US Treasury bond, a favorite MLP benchmark. That spread has widened to over 8.5 %.
No income investor should be without some of these. We recommend no more than 3%-5% of one’s portfolio in any one security. Given market volatility, take a third of total planned position in EPD now.
Disclosure: The author owns shares in the above companies.