Energy Infrastructure MLPs: Among the Very Best High Dividend Stocks

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 (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.

CONCLUSION

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.

More on other MLP recommendations is coming soon. Can’t wait? Take a look at Kinder Morgan Energy Partners (KMP), and TEPPCO PARTNERS LP (TPP).

Disclosure: The author owns shares in the above companies.

Comments

[You're Kidding:]

If they are so good of an investment, why not put most or all of a portfolio in them? What's better right now anyway? And hasn't the market proven lately that all boats rise and fall pretty much the same?

Jan 23 08:50 AM

[longoil:]

I agree with you in general about investing in MLPs, however you recommendation of Kinder Morgan Energy at the end of your article is highly questionable.

KMP is very risky based on key ratios.
Dividend is low at 4%. I get 5% to 15% from my MLPs & Canroys.
Price-to-book = 2.75 (overvalued)
Price-to-Earnings = 27 (too high for my liking)
Debt-to-equity = 1.7 (too high for me)

In conclusion, the payout is too low for such a risky company.
There are better deals out there with ERF, PWE and COSWF.

Jan 23 10:52 AM

[notsosmart:]

rising & falling boats have nothing to do with dividends.if you are paid every year a good dividend the value of the stock means nothing.in fact if it falls you buy more as i have done.so unless you are a trader this is the way to go.

Jan 23 10:54 AM

[User 304628:]

Confused EDP or EPD???? It is listed one way in this article & different in your blog.

Jan 23 12:05 PM

[Do not own BRK:]

Longoil,

Think you looked at the payout - it is paying $4.20
on an annualized basis with the latest $1.05 payout
announced. That's 8.56% at todays price. The Canroys you mentioned have oil price risk that KMP does not have, as well as currency risk. The Canadian Gov also holds back a portion of dividends for taxes, for which you then have to claim credits.

Jan 23 03:13 PM

[RichardGC:]

Longoil

Where are you getting your dividend yield information?
Current price = $49.25 +/-
Dividend $4.20 (just increased from $4.08) = 8.5% +/-.

"KMP is very risky based on key ratios.
Dividend is low at 4%. I get 5% to 15% from my MLPs & Canroys."

Jan 23 03:18 PM

[Turnipseed:]

You should note there are tax considerations even in IRAs. Also, there are a wide variety of MLPs including some that are oil/gas producers.

Jan 23 04:44 PM

[ruthEbel:]

It's definitely EPD (a quick check on stockcharts shows you that).

KMP vs PWE? I'm down some 46% on my PWE, only down 14% on my KMP... so which is more risky? Somehow a 28%yield on the PWE seems too good to be true so maybe something fishy? Note that they just cut their distribution from .34 to .23 for next 2 months, so I hope no one is depending on that dividend.

I'd like more info on how to understand MLP accounting and how to evaluate them. Where can one get comparable payout ratio data? Isn't this a crucial piece of info? They all have very high debt loads.

The yield info often does not take currency exchange rates into account on the Canadian trusts. It's beyond me to figure out exchange rate effects.

re K-1 form: I do aarp volunteer taxes and we were told this year we could do the K-1 forms; so, it can't be too complicated. I gather these should not be in an IRA for some obscure reason. Would like more info on that cuz I have KMP in my ira account.

Jan 23 09:03 PM

[d_teller:]

In answer to ruthEbel- re holding a MLP or a Holdr or a limited partnership in a tax-sheltered acct.:

The problem for the owner of the S or SEP or IRA is the K-1 form on which the partnership or ML-Holdr or other type of K-1 reporting entity (such as GLD or DBA) reports its pass through of profits and losses to the limited partners.

The history of this is way back when Congress allowed such Publicly-traded partnerships to form, they required a tax-shelter registration which says the nature of the business...so that if an MLP or PTP has income that is NOT from the registration type , then this income is considered to be "Unrelated to the Business for which the Registration was filed"...and is item 20V in the K-1. This was to protect ordinary, tax-paying corporations from the competition of a company which did not have to pay income taxes.

This UBIT or UBTI (Unrelated Business Taxable Income) may not exceed $1000/tax reporting individual in a shelter...or the shelter ---that is the IRA itself, not the beneficial owner- needs to file a 990t income tax return to the IRS. The Fiduciary can pay the tax from the IRA, but the owner may not...it's after that fiscal year, and the fiduciary has to create a tax-identification number for that sheltered account.

Further, failure to file/pay may disqualify the tax-shelter for the individual...and the K-1 data are reported...not necesssarily by the brokerage or fiduciary who holds the records, but by the security's accountants directly to the IRS...with their registration # and the taxpayers account # automatically, and electronically filed in March of the following year (03-15-09 for end of year 2008).

So if the total UBTI for your traditional+SEP+S+Roth exceeds 1000.00, then the tax-shelters are disqualified and taxable.

So you have to notify Fiduciaries who report your ususal 5498 end-of-year holdings to the IRS about the 20V amounts and get them to file a tax return to the Feds! They charge $200-2000 for the paperwork.

That's the reason to NEVER HOLD A SECURITY THAT ISSUES A K-! in a tax-sheltered account...unless the fiduciary will set up a TIN and file a 990t for you (these are so-called 'self-directed' IRAs).

UBTI from energy transfer or pipeline partnerships occur when pipelines are sold , or funds are borrowed by the MLP to develop additional business.

There are stock (C-Corporations not MLP's) that are the beneficial owners of MLPs, and are standard, 1099-filing entities, KMR /KMP, EEQ/ETP, etc. They get a part of the MLP's income, and pay taxes, and they're also high dividend paying, but less dangerous holdings in a tax-shelter.

Finally, all of the MLPs K-1 tax-loss and return of income (in lieu of dividends, which might get a short-term marginal taxation, many give a return of capital- which in taxable accounts reduces the basis, and converts income to long-term cap gains, at a beneficial reduction of tax rates) - ARE TOTALLY WASTED in a Tax-Sheltered Account, because the ouput is taxed at marginal rates, or just reduces the capital basis of a Roth.

Go to the IRS.gov site and look up the term UBIT or UBTI. Tax-sheltered entities do have to pay Income tax on unrelated business income: charities, IRAs, Churches, etc.

Jan 23 11:11 PM

[elliot_mllr:]

Redarers should also look at ETP.

Jan 24 01:01 PM

[ruthEbel:]

Big thanks to d_teller for tax info on MLPs. I'm a little guy, <1000 UBTI so I guess I'm ok for now. I will be sure to buy any MLPs in non-ira account. Maybe I'll even sell it out of my ira, then buy more in my other acct just to avoid possible complications.

Jan 24 01:47 PM

[mc2406:]

One concern is that with the credit markets being what they are right now, these MLPs may have to resort to floating additional shares to raise capital which will depress prices even more. Can't beat the dependable dividends though. Also look for OKS (formerly Northern Borders).

Jan 24 03:23 PM

[d_teller:]

This' a general comment re some posted above ("longoil'; "ruthEbel" & "Scimitar"

Scimitar is right about states trying to tax an out-of-state MLP-security holder, and if your state has a reciprocity agreement with the state levying this tax, a lien on your property may occur. Arizona, California and Nevada MLPs are subject to this extortion, Texas domiciled MLP's aren't. I haven't checked all the diferent states, but the paperwork to file is much worse than plugging K-1 data into Turbotax or TaxAct. Even when a security is held in a tax-sheltered account, the states will try to tax it...in violation of Federal rules.

Tim Plaehn, a frequent contributor to the SA articles, wrote a nice comparison of 3 of the ATLAS pipeline MLP family, to compare their earnings, debt, funding etc. The article noted is #104942.

Some other MLP prospects (or their C-Corp. equivalents) have shown diametrically opposite recent movements; e.g. Kayne Anderson: [KYN (down) KYE (up)].

Another interesting one is an MLP called ATN...which also has some articles listed here.

Finally, for the securities called 'Canroys", not all are affected by the Cdn. govts. plan to require income taxes at the source in 2011, specifically:

REITS are not affected - and many of the lesser-known ones that earn income from U.S. holdings, are not to be subject to Cdn Income taxes, either.

One example of the latter is "Atlantic Power Income Trust", ATPWF, {ATP.UN on the TSX}. It's a power generating utility income trust with power plants in the U.S. In a taxable account, the 15% withheld in Canada is a tax credit vs the income on a U.S. 1040, so its dividends will be "tax-qualified", unless the foreign tax-credits are repealed after the "qualified" dividends are in 2011. In an tax-sheltered account, these 15% Cdn withholdings on dividends aren't recoverable, currently.

Jan 24 09:27 PM

[sligoo:]

I am now totally confused about what my exposure is for getting into trouble with the Intrenal Revenue Service about dividends that MLP's pay into my IRA. I own several pipeline partnerships in my IRA. The amount I received in TOTAL each year DOES exceed $1000. Does the $1000 limit protect me from filing a K-1?

Jan 25 09:10 AM

[ArtfulDodger:]

d_teller:

What about church and charitable accounts that are not taxed?

Is there any K-1 requirements for them?

Thank you for your help and info. AD

Jan 25 12:30 PM

[sligoo:]

You stated that "most MLPs have to fill out a K-1". Which parterships do NOT require this ?


On Jan 23 07:03 AM scimitar wrote:

> Cliff,
>
> Good article! However, I think you should mention the fact that investors
> in most MLPs have to fill out a K-1 form on their tax return. In
> some cases, you may be required to pay additional taxes in each state
> where the MLP operates. Nevertheless, I think MLPs are great, and
> if it weren't for the complex tax issues, they'd be nearly perfect.

Jan 25 12:50 PM

[d_teller:]

To "Sligoo" --

The K-1 forms are sent by the MLP's accounting office...not the fiduciary 9the brkerage) that holds your securities (who may not have a clue what's on a K-1 that you receive, because the identifiers on the K-1 are your Tax shelter account {RA Account #} and their Tax Shelter restistration number) (and they come in late March and early April, way after any 1099's from "usual' trades and dividends arrive)...

BUT-


it's only if ITEM 20 V sums up to more than USD$1,000.00 in all of the IRA's that a 990t has to be filed and tax paid to the Feds.


For an example...DBA's K-1 comes from Deutsche Bank...the index provider: I held DBA for a while, and they reported >$10K in "dividends" from contracts and straddles on a K-1 that I received in one of my IRA's. I called the IRS and checked and the IRS reaffirmed that the income to the IRA was not reportable...only any excess of $1K across the IRA's under K-1 Section 20 V was a concern.

To: "ArfulDodger"-

Yes charities, and religious tax-exempt organizations have similar rules, The form they file is (I believe) a 920t - similar in purpose to the 990t.

And there's a whole list of other forms for these tax-exempt entities to file on income received. They are usually listed under IRC 501(c).

And to all, above, who've questions...the taxpayer receives (doesn't fill out) the K-1...and each comes with a diagram for where on schedule A, or E or C, the amounts are to be entered. None of this is entered if the K-1 is in an IRA---only Item 20V is a problem -- and only if the sum for all tax-sheltered accts is >1K.

...then, one has to notify the fiduciary of one of the IRAs to file a 990t and they charge $ for the Taxpayer (IRA pays the tax) Number Setup forms (TIN forms for an IRA) and for filling out the 990t Unrelated Business Income Tax forms and sending sufficient proceeds from the IRA to cover all the taxes due to excess UBTI.

Jan 25 10:21 PM

[PeteK:]

longoil;
Don't forget, starting 2011, the Canadian gov. will start tax the Hell out of those so call dividends you are now getting.
Check it out for yourself.

Feb 01 02:22 AM

[Mad Hedge F...:]

The longer crude stays below $40, the more production is being taken off the market. At this stage all 35 million barrels of storage at the Cushing, Oklahoma delivery point for west Texas intermediate are brimming with crude. The 709 million barrel Strategic Petroleum Reserve (SPR) is nearly full. And there is another 50 million barrels stored in supertankers at sea which is building by the day. Demand has collapsed so fast, that oil companies can’t shut down production fast enough. The scary thing about this is that when the next crude spike upward in crude comes, it will be worse than the last one. Take advantage of the current distress prices to accumulate oil infrastructure stocks. Kinder Morgan Energy Partners (KMP) has a PE multiple of 25 and a dividend yield of 8.3%. Enterprise Products Partners (EPD) has a $10 billion portfolio of fractionation facilities, storage, offshore drilling platforms, and 32,478 miles of product, natural gas, and crude pipelines, and carries a modest PE multiple of 12 X and a dividend yield of 9.2%. More expensive Kinder Morgan Energy Partners (KMP) with a PE multiple of 25 X and a dividend yield of 8.3% is also worth a look see.

Feb 20 12:37 PM

[ArtfulDodger:]

Thank you d-teller for your reply! AD

Apr 20 04:02 PM