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A yield hound's delight

Recs

27

April 15, 2009 – Comments (10) | RELATED TICKERS: WMZ.DL , ETE

 

I'll admit it.  I have evolved into a complete yield hound.  I love corporate bonds with juicy yields of near 10%.  I also love dividend paying preferred and common stock.  When I purchase stock in a company, I become a part owner of it.  As an owner, I demand that my company share at least a little of its profits with me.  Is that too much to ask?  I personally don't think so.

By focusing on yield instead of growth I wil almost certainly miss out on the next monster 100 bagger that most investors dream of.  On the other hand, I will generate real cash earnings for my portfolio and I probably won't get demolished either if the growth and multiple expansion that others are looking for never materializes.

This week's Barrons contains an excellent article on a type of investment that pays excellent dividends right now, MLPs.  Master Limited Partnerships, MLPs for short, are companies in the real estate or natural resources sectors that receive special tax treatment from the U.S. government in exchange for paying out a larger percentage of their earnings to investors as dividends.  OK, technically their payments aren't dividends, they are "income distributions" to "unitholders."  There is an important distinction between the two as far as the IRS goes.  Anyone who is considering purchasing MLPs, should give serious though to doing so through an IRA instead of in a regular account.

Anyhow, the Barron's piece spoke highly of a sub-sector of the MLP universe, natural gas pipelines.  The author likes natural gas pipelines because they are less impacted by fluctuations in the price of oil and gas than E&P (exploration & production) companies.  Furthermore, they have valuable assets that government regulation turns into near monopolies.

Though I don't own any of the companies that the author mentioned in the article, I like pipelines as a segment and I have added the stock of a number of pipeline operators to my and my wife's real world IRAs over the past year, including Boardwalk Pipeline Partners (BWP), Kinder Morgan Energy Partners (KMP), & Magellan Midstream Partners (MMP).  I also own Lakehead Pipeline's (a division of Enbridge Energy Partners LP (EEP)) 7% 2018 bonds that sport a YTM of around 9%.

The two specific companies that the author of the article seems to like best are Williams Pipeline Partners (WMZ) which currently yields 7.2% and Energy Transfer Equity (ETE) which sports a 8.7% yield.

Williams Pipeline Partners is relatively small (a market cap of $367 million) and new (it was created in 1/08) limited partnership that owns a 35% interest in a pipeline that transports nat gas from New Mexico to the Pacific Northwest.  It's the only interstate pipeline operator with operations in Boise, Portland, and Seattle.  Williams Company (WMB), another attractive company that I recently added to my CAPS portfolio, owns the other 65% of the pipeline. Best of all, WMZ has virtually no debt.  The MLP analyst at Stifel Nicolaus believes that there is a good chance that Williams Companies, WMZ's creator, will place additional assets in it in the future to help boost its returns.

Many analysts value MLPs based upon their "coverage ratio", which is equal to their distributable cash flow per unit divided by their distributions per unit.  If a company's ratio is larger than one, it can continue to pay distributions at its current level.  The Stifel Nicolaus analyst estimates that WMZ will have a coverage ratio of 1.1 in 2009 and 2010, so it shouldn't have to cut its distribution.

Energy Transfer Equity is the majority owner of Energy Transfer Partners, a pipeline operator in Arizona, Colorado, Louisiana, New Mexico, Texas, and Utah. The company also stores, treats, and processes nat gas.  Morgan Stanley's analyst is very bullish on ETE and she believes that it will increase its distribution very rapidly after the new pipeline that it is building to transport gas from the Haynesville Shale on the Texas-Louisiana border is completed in 2011.  The addition of more pipeline assets will enable the company to reduce the commodity price risk that is associated with processing.

While I don't currently own either WMZ or ETE in real life, I have added both to my CAPS portfolio.

 Juicy Yield Play

Deej

10 Comments – Post Your Own

#1) On April 15, 2009 at 2:49 PM, tfirst (36.80) wrote:

MIC

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#2) On April 15, 2009 at 3:05 PM, Tastylunch (29.54) wrote:

Yea MLPs can be a nice way to get a good yield.

 I like WES myself Deej, natural Gas midstream (pipeline etc) spinoff of Anadarko. I think it's underfollowed since it's fairly new.

8% yield

I wrote my pitch here on it if 

http://boards.fool.com/Message.asp?mid=27469962&sort=collapsed Report this comment
#3) On April 15, 2009 at 4:29 PM, charlesblazer (99.02) wrote:

For the past year, much of my CAPS portfolio has been MLPs and royalty trusts.  I like natural gas pipeline MLPs for the exact same reasons you do.  Originally, my thesis behind these picks was that they are theoretically market-neutral, meaning their "share" price should remain steady and they should continue yielding "dividends" even while the market declines -- resulting in a positive CAPS score heading into this recession.  In reality, over the past year I've observed that the "share" prices have fluctuated (generally declined) more than I expected, but they still outperformed the S&P.

I think it was a great play heading into the recession, but there's a chance it will underperform during a recovery (if/when that comes), depending on the rate of recovery.  So for those who believe that we've seen the bottom and that now we're recovering, the theoretically low market-correlation of midstream MLPs is a "risk" to consider.  For those who predict a long, flat bottom (or further decline), the consistent yield of MLPs still looks like a good play to me.

Deej, what are the implications of trading MLPs in an IRA, that you hinted at?

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#4) On April 15, 2009 at 4:32 PM, awallejr (82.72) wrote:

I love them too, but a bitch dealing with the K-1s.  If in an IRA account you wouldn't have to worry about that, but  wouldn't you then lose out on their special treatment?  Couple others I like are PVR (coal out of favor atm but long term demand, especially from China should help), LINE, EVEP, BBEP.

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#5) On April 15, 2009 at 4:32 PM, Gemini846 (82.65) wrote:

I've heard quite the contrary to the following: 

There is an important distinction between the two as far as the IRS goes.  Anyone who is considering purchasing MLPs, should give serious though to doing so through an IRA instead of in a regular account.

MLP distributions are treated as a reduction to the basis so they increase your capital gain when you sell. Theoretically you could never sell and pass it to your kids with a 0 basis collecting income on it your whole life.  Of course its treated this way since in theory the "resource" will run dry and you'll have to face the tax man.

Regardless since this "return on capital" is considered taxible you'll pay when you sell even if you hold it in an IRA.  That can be a rude awakening.

At any rate I reccomend these to anyone who is chasing return, especially older investors who are hands on enough to handle the tax issues.

Disclosure: Long KMP and STON

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#6) On April 15, 2009 at 8:46 PM, bigpeach (31.51) wrote:

Another good post Deej on a blog board full of crap. Gemini explained one of the tax consequences of MLPs. It's also worth pointing out that dividends from some of these are taxed as ordinary income rather than at the dividend tax rate. This is a consequence of the partnership not having to pay corporate taxes. For higher tax bracket individuals, that can turn a seemingly high yield into an ordinary after tax yield. Somebody correct me if I'm wrong, but I believe holding these in an IRA as you alluded to will prevent you from having to pay any tax on income distributions, preserving your juicy yield.

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#7) On April 15, 2009 at 10:51 PM, schowlera (86.81) wrote:

Good post deej, I agree, I am becoming a huge fan of significant yields and building a consistent supplemental "pay check" in the process.  I am still young with many years until I technically have a need to be classified as an income investor but the current market has given one of those few times in a lifetime opportunities to build a solid personal portfolio at good prices. 

Regarding the taxes, for anyone interested in learning about MLPs I highly recommend googling "Alerian Capital Management MLP Primer" and reading the PDF.  In addition to a solid understanding of the industry, you will get an explanation of the taxes on page 42 but for those looking for the cliff notes:

- MLPs pay distributions (return of investor capital) not dividends

- Distributions are considered a return of capital which adjusts the investors basis and are not taxable and remain that way until either the investor sells the shares (though the adjusted/decreased basis increases the gains) OR the adjusted basis in the units reaches zero.

Regarding IRAs, I probably discourage investors to place this type of investment in an IRA due to UBTI (Unrelated Business Taxable Income).  A portion of the money made from the MLP is considered UBTI and if your personal UBTI exceeds $1000 for the year, the excess will be taxable regardless of being in a tax sheltered account.  Plus the original distributions are not taxable anyway under the terms listed above.  Why would you want to lock that money up in an IRA prison if you don't have to?

So if anybody has made it to the end of this post, what type of personal portfolio yield from dividends/distributions are you achieving/striving for? 5%, 10%, 15%....?

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#8) On April 16, 2009 at 6:37 AM, TMFDeej (99.46) wrote:

Thanks for the comments and the information on the tax consequences of MLPs everyone.  They certainly are tricky as far as taxes go (that's why I have an accountant ;)) but their juicy yields make them more than worth the trouble in my humble opinion.

Deej

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#9) On April 16, 2009 at 11:42 AM, garyc27 (< 20) wrote:

Deej,

I'm curious as to why ATN was not mentioned.  It has a 5 star CAPS rating and an 18% yield.  I own it which is why I'm asking.  Thanks,

Gary

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#10) On April 16, 2009 at 11:44 AM, OleDrippy (35.19) wrote:

Great post, thanks.. I think the tax consequences are probably the most important thing to think about..

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