Tuesday, May 31, 2011

High Energy Partnerships -- Dividends

6 Mid-Cap Oil & Gas MLPs Currently Offering Yields Above 6%

Why Mid-Cap MLPs?

Master Limited Partnerships (MLPs) are a growing asset class. There are a few giants in the business. However, these middle-sized MLPs may be preferable because they offer better potential for growth. Simply put, a $3 billion company goes up by 33% if another billion enters it, while a $10 billion company would only go up 10% in that situation. Howver, it works the same way when funds depart. Thus, there is risk.

There has been significant growth in interest for this asset class. This growth is most notably from individuals at or near retirement age who are looking for higher yield options in a low yield world. These partnerships have appreciated with the oil markets, and may be overvalued in the short term. Nonetheless, as more money comes into the MLP asset class in search of income, it is likely that M&A activity will begin to heat up within the industry. Such M&A activity tends to benefit the smaller market participants, as they are acquired by the larger participants.

Another reason that mid-cap MLPs may outperform the larger ones is their lack of recognition. Fewer analysts follow them. As MLPs become more accepted and ownership becomes more common, the checken-and-agg effect of growing analyst coverage will most likely lead to more trading, which, mixed with rising energy prices, is likely to lead to higher share prices for these already high-yielding securities.

Six Mid-Cap MLPs That Currently Yield over 6%

Boardwalk Pipeline Partners LP (BWP)

Yield: 7%

Market Capitalization: $5.62 billion

Debt: $3.27 billion

Buckeye Partners LP (BPL)

Yield: 6.3%

Market Capitalization: $5.83 billion

Debt: $2.64 billion

Enbridge Energy Partners LP (EEP)

Yield: 6.7%

Market Capitalization: $7.9 billion

Debt: $5.25 billion

Nustar Energy LP (NS)

Yield: 6.9%

Market Capitalization: $4.1 billion

Debt: $2.4 billion

Plains All American Pipeline LP (PAA)

Yield: 6.3%

Market Capitalization: $9.25 billion

Debt: $5.59 billion

Regency Energy Partners LP (RGNC)

Yield: 7%

Market Capitalization: $3.5 billion

Debt: $1.22 billion

Many of these names, like the larger MLPs, have appreciated considerably over the past year. Due to this appreciation, it may be wise to prepare a list of those with characteristics you like and watch them for a better entry price. Of course, if you had chosen that course of action six months ago, you probably would have missed out on some decent growth and/or distributions.

MLPs and Taxation

MLPs are partnerships, so they do not pay corporate income taxes, on either a state or federal basis. They are fairly similar in this regard to the once great Canadian Royalty Trusts (Canroys) that Canada recently eliminated, forcing restructuring. Additionally, the investing limited partner might be able to record a pro-rated share of any depreciation to reduce tax liability. However, this theoretical advantage does not exist where the MLP is held in a tax-deferred account, such as an IRA. Nonetheless, they are often effectively used in IRAs for their high yield characteristic alone.

The tax liability of the MLP is passed on to its holders. Each investor receives a K-1 statement that details their share of the partnership's net income. That income is then taxed at the investor's individual tax rate. The MLP may also make cash distributions that are not taxed received, but reduce the cost of partnership shares/units and create a tax liability that is deferred until the MLP is sold.

An ETF and Why CEFs are an Issue

I would also like to mention that the ALPS Alerian MLP ETF (AMLP) is an ETF that provides exposure to a basket of MLPs that is supposed to correspond to and track the Alarian MLP Infrastructure Index. The annual expense ratio is listed as 0.85%, which is slightly above average for an indexing ETF, but this option may be preferable to individuals that desire diverse exposure to the asset class, or to those that do not feel confident picking and choosing individual names within the asset class.

There are also some newer MLP Closed End Fund (CEF) options that many may prefer because they are designed to produce a 1099 rather than a K-1. These CEFs are usually preferred by individuals that want to hold MLP exposure in an IRA or those that just don’t want to file a K-1. While there may be some reasons to hold such a CEF, their corporate structure essentially counters the tax pass-through characteristic of the investment plus expenses. If that was a good idea, why wouldn't these businesses structure themselves as corporations?

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