The Master Limited Partnership Opportunity Of 2018

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About: JPMorgan Alerian MLP Index ETN (AMJ), Includes: PAA, WPZ
by: Retirement Watch

Summary

Master limited partnerships (MLPS) were among the market darlings following the financial crisis, delivering high yields, rising prices and tax advantages.

MLPs crashed with the price of oil from mid-2014 through early 2016.

However, MLPs are well-positioned for a return to stability and growth in the future. Insider buying is increasing, and MLPs appear to be finding a bottom.

Master limited partnerships (MLPS) have had a tough few years.

They were among the market darlings following the financial crisis, delivering high yields, rising prices and tax advantages. MLPs crashed with the price of oil from mid-2014 through early 2016. They initially recovered with oil, but MLPs declined much of 2017 and now are near their lows of 2016.

Several factors account for the 2017 weakness. Those factors are abating and setting the stage for at least stability in the sector and perhaps some price appreciation to accompany their high yields.

The declines in late 2017 are attributable to two temporary factors.

First, an early tax reform proposal would have reduced the tax benefits of MLPs. The more recent versions allow MLPs to continue to avoid taxation as long as most of their income is passed through to owners.

Also, MLPs traditionally are weak late in the year because of year-end tax planning by the individual investors who dominate the market.

Second, most of the 2017 decline, however, was due to carryover effects of the 2014-2016 bear market. Some MLPs took on too much debt or created too much capacity during the boom period. They deferred the reckoning for as long as possible before announcing distribution cuts and other changes in 2017.

In addition, most of the midstream MLPs decided structural changes were in order if they want to deliver the consistent income and returns investors have come to expect. Midstream MLPs are the pipelines and storage facilities most investors associate with "MLPs." Many key MLPs undertook that restructuring in 2017.

The restructuring included reducing debt and planning to fund future expansions from internal cash flow, instead of issuing new equity or taking on more debt. Some also announced plans to reduce capital spending in the next few years. There also were some mergers, and there are likely to be more mergers and consolidations in 2018.

Announcements of reduced payouts to investors were a result of the restructuring. Several widely-held MLPs, such as Plains All American Pipelines (PAA), announced payout reductions and roiled the market. Since most MLP investors are seeking high income, payout reductions lead to re-pricing of MLP interests.

The good news is the changes mostly are behind us and set MLPs up for a return to stability and growth in the future. Insider buying is increasing, and MLPs appear to be finding a bottom.

I recommend owning MLPs through the J.P. Morgan Alerian MLP ETN (AMJ).

AMJ is an exchange-traded note (ETN). Investors own no equity. They own a share of a promise from J.P. Morgan bank to pay them the return of the Alerian MLP index (minus fees and expenses) and to make quarterly income distributions. The ETN is unsecured or collaterized; investors are general creditors of J.P. Morgan. The index is a capitalization-weighted index of the 50 largest MLPs.

I like AMJ because it avoids many of the potential tax problems that frustrate MLP owners. The ETN issues a Form 1099 each year, while an individual MLP will issue a K-1. The investor isn't potentially responsible to file an income tax return in each state in which an MLP does business. The ETN also can be owned through an IRA or other qualified retirement account without having to worry about the Unrelated Business Income Tax (UBIT) rules.

There are other entities that also are structured to invest in MLPs without the tax complications, but I find these have much higher expenses and don't deliver consistently higher returns than the ETN. Some are structured as corporations, for example, and pay corporate income taxes. These taxes reduce the amount available to distribute to investors.

The top holdings of the index are Magellan Midstream Partners (MMP), Enterprise Products Partners (EPD), Energy Transfer Partners (ETP), MPLX (MPLX) and Williams Partners (WPZ).

The MLP sectors in the index are Pipeline Transportation/Petroleum (37.6%), Pipeline Transportation/Natural Gas (29.1%), Gathering & Processing (25.9%), Marketing (4.2%) and Other 3.2%.

AMJ is down 8.20% for the year to date and 3.43% over one year. But it is up 1.83% in the last four weeks. The 12-month yield is around 7%. I recommend buying anywhere near the recent price of $27.22.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.