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Patience Should Pay Off With Master Limited Partnerships

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Monday, 30 May 2011 11:17 AM Current | Bio | Archive

After more than a decade of spectacular Master Limited Partnership (MLP) returns, prices have begun to tumble along with commodity prices.

Does this mean it's time to take profits?

The spate of bubbles over the past decade provided a sobering reminder that prices don't rise forever. And, prices of many MLPs have been climbing for a long time.

The Alerian MLP Index (a benchmark index comprised of 50 of the largest MLPs in the energy industry) has returned investors an astounding average annual return of better than 17 percent per year for the last 10 years, compared to just over 3 percent for the S&P 500 over the same period.

Returns have been especially impressive recently, averaging 20 percent over the past three years and 33 percent over the last year (as of March 31). But commodity prices began to tank in May. As a barrel of oil plunged from over $113 per barrel to less than $100, the MLP index plummeted 10 percent between just late April and mid May.

MLPs have since bounced back and recouped some of the slide. But, was this recent sell off a warning and an opportunity to take profits or just a blip with more solid returns to come?

I believe in the blip theory and think investors should hold tight. Obviously, not all MLPs are the same and should be considered on a case by case basis. But, many MLPs still provide answers for today's market.

Here are some reasons why:

Predictable Cash Flows

While it's true that MLP prices often fluctuate with commodity prices in the short term, many generate cash flows that remain consistent regardless of volatile commodity prices.

MLPs can include companies involved in shipping, real estate and finance but the overwhelming majority are involved in the energy industry. Most of these energy MLPs operate pipelines and are toll collectors paid for the service of storing and transporting fuel rather than selling energy. Much of the income is fee-based, often under long term contracts, with cash flows insulated commodity price changes.

Throughput volumes are susceptible to a slowing economy as demand for energy softens, but some MLPs have expansion projects under way that can boost earnings regardless of the economy.

Income

MLPs pay no income taxes at the corporate level provided they pay out the bulk of earnings to unit holders in the form of distributions. This gives MLPs a huge advantage over corporations (which pay 35 percent of profits in taxes) as they are able to beef-up distribution income with money that ordinary corporations lose to taxes.

As a result, the Alerian Index yields nearly 6 percent, a compelling lure for income investors while the average yield on the S&P 500 is just 2 percent.

Inflation Protection

Many pipeline MLPs benefit from regulated annual fee increases that are tied to inflation (generally PPI + 2.65 percent), enabling profits and distributions to rise right along with inflation.

One particular MLP of note is Magellan Midstream Partners L.P. (NYSE: MMP). Magellan has a huge pipeline network for refined fuels that is connected to 40 percent of U.S. refining capacity. About 85 percent of the LP's revenue is fee-based and indexed to inflation and Magellan has significant growth projects under way that should insulate earnings from possible lower demand in a slowing economy. MMP currently yields over 5 percent and has a strong record of growing the distribution.

There is always the possibility that MLP prices could get hit again if the economy slows and/or commodity prices fall. But, the solid fundamentals should win in the longer term. Current MLP investors who need income should ride out short-term volatility. New investors can use any future weakness in MLPs as an opportunity to get in.

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TomHutchinson
After more than a decade of spectacular Master Limited Partnership (MLP) returns, prices have begun to tumble along with commodity prices. Does this mean it's time to take profits? The spate of bubbles over the past decade provided a sobering reminder that prices don't...
tom,hutchinson,mlps,Master,Limited,Partnerships
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2011-17-30
Monday, 30 May 2011 11:17 AM
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