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 (especially in times of economic uncertainty).
As shown in the chart below, the Alerian MLP Index continues to outperform other yield-driven indexes like the FTSE NAREIT Index and the S&P 500 Utilities Index.
As highlighted in Standard & Poors Guide to MLPs, MLPs offer investors three distinct positive characteristics:
- 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.
- 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.
- 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.
Two Types of Partners in an MLP Structure
There are two types of partners in an MLP structure, a general partner and limited partners.
The general partner manages the MLP and is incentivized through Incentive Distribution Rights ("IDRs"). IDRs provide incentive for the general partner to increase the cash distribution per unit over time by allowing the general partner to receive increasing percentages of available cash flow. Most MLPs have a tiered structure for sharing available cash between the general and limited partners, with the general partner working from an initial 2% up to a potential 50% payout of available cash.
Limited partners are not involved in the day-to-day management of the MLP, and have limited liability. Once the MLPs reach the highest IRD threshold the distribution growth for limited partners slows down, while it increases for general partners.
The five General Partners in the table below currently have an average dividend yield of 4.9% and offer stable yields with upside potential (through IDRs)
Energy Transfer Equity (ETE) owns the general partners of Energy Transfer Partners (ETP), a large-cap diversified MLP and Regency Energy Partners (RGP), a gathering and processing MLP. In addition to a 2% general partnership interest and IDRs, ETE owns approximately 50.2 million ETP limited partner units and approximately 26.3 million RGP limited partner units. The 2011 expected distribution is $2.44.
Kinder Morgan (KMI) owns the general partner of Kinder Morgan Energy (KMP), a large-cap diversified MLP. In addition to a 2% general partnership interest and IDRs, KMI owns 11% (or approximately 36 million units) of KMP. The 2011 expected distribution is $1.22.
NuStar GP Holdings (NSH) owns the general partner of NuStar Energy L.P. (NS), an asphalt refiner and marketer and operator of petroleum product terminals and petroleum liquids pipelines. In addition to a 2% general partnership interest and IDRs, NSH owns 15.5% (or approximately 10 million units) of NS. The 2011 expected distribution is $2.00.
Targa Resources Corp. (TRGP) owns the general partner of Targa Resources Partners (NGLS), a provider of midstream natural gas and natural gas liquid services. In addition to a 2% general partnership interest and IDRs, TRGP owns 15.4% (or approximately 11.6 million units) of NGLS. The 2011 expected distribution is $1.19.
Crosstex Energy Inc. (XTXI) owns the general partner of Crosstex Energy LP (XTEX), a midstream energy MLP focused on gathering and processing. In addition to a 2% general partnership interest and IDRs, XTXI owns 25% (or approximately 16.4 million units) of XTEX. The 2011 expected distribution is $0.42.
Disclosure: I am long KMI.