Thursday, July 26, 2012

Boring Terms We Need To Know: Master Limited Partnership (MLP)

Master Limited Partnerships (MLPs), it just sounds like a boring term doesn't it.  MLPs, like REITs, are typically strong dividend payers because they pay out most of their generated cash flow to investors, or "unit holders", in lieu of paying taxes.  I've had several readers email me asking me to do a dividend analysis on specific MLP stocks. Since MLP's operate differently than normal stocks though, running them through my current dividend analysis (growth or income) wouldn't be valid.  So I guess I need to add a MLP Dividend Analysis Template to my "to-do list".  Before I do that though, it would be a good idea to educate those of you aren't familiar with this type of stock and what we should consider before investing in them.

MLPs have their strengths and weaknesses as a dividend stock.

  1. MLPs are desirable to income-oriented investors with higher than average yields.
  2. A portion of the distribution (dividend) may be shielded from ordinary income taxes.
  1. Taxes can be more complicated as MLP's dividends are taxed differently than normal dividend income.  You get a separate form when reporting MLP income called a K-1. Because of the complicated taxing, if you choose to reinvest dividends from an MLP you will likely create a tax headache if/when you sell any of the stock.
  2. There are restrictions from owning a MLP in a retirement account (but there are ways to work around this, I'll explain that in a later post).
  3. For some MLP businesses, dividends can vary from year-to-year creating a less reliable income stream.
A MLP structured company can be involved in various businesses such as real estate, commodities, or natural resources such as propane; but the majority of MLPs are involved in energy production and transportation (pipelines).  MLPs have typically borrowed a great deal of money and / or raised cash by issuing units (stock) to investors.  It uses this money to build out infrastructure or invest in assets that can then be used to create a reliable income stream to be paid out to it's unit holders (shareholders).

My personal feelings on MLPs are that they can be a strong, reliable source for dividend income. They aren't a great choice for dividend reinvestment, unless you have a good accountant or you enjoy tax paperwork. You need to be selective and do your homework before investing in a MLP.  High debt is typical for a MLP,  so you want to be sure the company can handle its debt load and have enough cash left over to pay out its distributions.  Also, you should be leery of MLPs that have double digit yields. Many times this can be a sign that the dividend payment can not be sustained or that future payments could fluctuate.

Below are descriptions and examples of companies that fall within each MLP business type.

Pipeline MLPs
Many MLPs supply transportation infrastructure for the energy industry.  These are companies that have laid down thousands of miles of pipeline across the country and then charge energy companies to use their pipeline to transport oil or natural gas.  The easiest way to think of it is a toll road.  A pipeline MLP uses its borrowed or raised money to build pipelines.  Once built, they then get to charge use of the pipeline based on how much oil/gas a company ships through the pipeline.
  • Kinder Morgan Energy Partners, L.P. (KMP) owns an interest in or operate approximately 75,000 miles of pipelines and 180 terminals.  
    • Current Yield: 5.9%
  • Enterprise Products Partners L.P. (EPD) owns an interest or operates over 40,000 miles of pipeline, as well as several processing and storage terminals.  
    • Current Yield: 4.7%
  • Energy Transfer Partners LP (ETP) currently has natural gas operations that include approximately 23,500 miles of gathering and transportation pipelines, treating and processing assets, and three storage facilities located in Texas.  
    • Current Yield: 8.0%
Exploration & Production
Exploration and production partnerships generally produce crude oil, natural gas, or coal from reserves that they own.
  • Pioneer Southwest Energy Partners (PSE) owns oil and natural gas reserves in Texas and in southwest New Mexico.
    • Current Yield: 8.1%
  • Linn Energy (LINE) owns natural gas reserves in the Texas Panhandle, Oklahoma, Michigan, and in the Los Angeles Basin.
    • Current Yield: 7.3%
Shipping partnerships fall into two groups. Some provide specialized oil or refined product transportation services in U.S. coastal areas, and the others are conventional oil tanker operators.
  • Teekay Offshore Partners (TOOFormed by Teekay Corporation, Teekay Offshore operates shuttle tankers used to transport oil from offshore fields to onshore processing facilities. Teekay Offshore also owns conventional crude oil tankers.
    • Current Yield: 7.3%
Propane Retailers
These partnerships sell propane and/or heating oil products to residential, commercial, industrial and agricultural customers.
  • AmeriGas Partners (APU) sells propane to 1.3 million residential, commercial, industrial, agricultural, and motor fuel customers from 1,200 locations in all 50 states.
    • Current Yield: 7.8%
Real Estate Property & Finance
These partnerships are typically involved in investing in mortgage related securities or financing apartment communities and apartment developers.
  • Ellington Financial LLC (EFCinvests in mortgage-related assets backed by single-family residential properties.
    • Current Yield: 12.7%

A more complete list of MLPs can be found here.

Disclosure: I am long PSE

Related Posts: Boring Terms We Need To Know


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