Buy the Dip on These 7 Large Cap MLPs

by: Parsimony Investment Research

Following the recent weakness in the general market, the Alerian Master Limited Partnerships (MLP) Index is down 7.2% since peaking on April 30th.

We view this as a great buying opportunity to purchase solid income-generating assets with great industry fundamentals.

MLPs generally offer stable yields that are typically higher than those of common stocks. In addition, MLP returns have traditionally had low correlations with stocks and bonds, making them good portfolio diversification assets.

As highlighted in Standard & Poor's Guide to MLPs, MLPs offer investors three distinct positive characteristics:

  1. Tax Treatment - Since MLPs are structured as partnerships they do not pay corporate income taxes. Taxes are only paid when distributions are received, thus avoiding the double taxation faced by investors in corporations.
  2. Consistent Distributions – MLPs face stringent provisions including the requirement to pay minimum quarterly distributions to limited partners, by contract. Thus, the distributions of MLPs are very predictable.
  3. Energy Infrastructure – The majority of MLPs operate in the energy sector, particularly in energy infrastructure industries such as pipelines, which provide stable income streams. The performance of companies in the energy infrastructure industry is not highly correlated with the price of oil and other types of energy, but rather with the demand for energy. The demand for energy is far less volatile than commodity energy prices and generally increases steadily over time, resulting in steady, predictable cash flows for companies in these industries.

Large Cap Diversified MLPs

Below is a list of the 7 largest MLPs, which have an average dividend yield of 6.3%. In addition, all of these MLPs have a cash distribution coverage greater than 1.0x, which generally indicates adequate reserves to cover cash distributions.

Of the 7 MLPs in the table above, we think that Kinder Morgan Energy Partners (NYSE:KMP), Plains All American Pipeline (NYSE:PAA), Enbridge Energy Partners (NYSE:EEP), and Energy Transfer Partners (NYSE:ETP) currently offer investors with the best risk/reward profile. As shown in the chart below, these MLPs are above the trendline in the risk/reward spectrum (i.e., yield should increase as unit price volatility increases).

Disclosure: I am long KMP, PAA, ETP.