Adding Holly Energy Partners as stock pick in my Dividend Income portfolio

05/31/2013 5:20 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

I’m going to make some buys and sells in my Dividend Income portfolio http://jubakpicks.com/  today.

In these buys and sells I’ll be adding Holly Energy Partners (HEP), one of the stocks I wrote about in my post http://jubakpicks.com/2013/05/24/10-u-s-traded-dividend-income-stocks-picks-for-a-yield-hungry-market/  That pick is the subject of this post.

I’ll also be selling two of the stocks, Total (TOT) and Magellan Midstream Partners (MMP) currently in my Dividend Income Portfolio out of that portfolio. I’ll explain the reasons and the timing for those two sells in posts later today. (I don't want to sell before I collect all the dividends that are on the table, right?)

But for the moment, I’d note that the buy of Holly Energy and the sell of Magellan Midstream both have a lot to do with my 5% rule of thumb for dividend plays in the current market.

What’s this 5% rule?

For more than a year now, I’ve been writing abut what I’ve called the new paranormal market. (To catch up if you’ve missed the foundation of this argument see my post from March 2012 http://jubakpicks.com/.) The premise of my argument is that we’ve entered a period of relatively low returns. Bill Gross, the bond guru at Pimco, calls this period the “new normal” and believes that we’ll be lucky to see average annual returns of 5% a year during this period, which could stretch out for a decade. In my model for the “paranormal market” I’ve added a wrinkle to Gross’s model. Not only will average annual returns be low by the standards of the great bull market that governed the 1980s and 1990s, but also markets will be extraordinarily volatile. So, yes, you might see an average annual return of 5%, but that average will include years of 10% or 15% drops as well as substantial rallies, and it will include years like 2011 when the market will produce a half dozen swings of 7% or more in a month as it did in August 2011.

Dividend investing—active dividend investing--is extremely important in this environment. Volatility will create repeated opportunities to capture yields of 5%–the “new normal” and “paranormal” target rate of return–or more as stock prices fall in the newest panic. By using that 5% dividend yield as a target for buys (and sells) dividend investors will avoid the worst of buying high (yields won’t justify the buy) and selling low (yields will argue that this is a time to buy.)

Holly Energy Partners, a master limited partnership, was spun off in 2004 by refiner Holly Corporation (now HollyFrontier (HFC)) in 2004 with assets that include 2,600 miles of pipelines, 12 million barrels of storage, and various terminals and truck loading racks. Holly Energy Partners has stumbled lately and that has moved the units decided above my 5% target. At a close of $35.96 on May 31 the dividend yield was 5.3%.

Of course, you don’t want to buy a dividend payer just because the yield has moved above 5%. Investors might be demanding a high payout because they think the company is in trouble or because they think the risk of holding this position is relatively high.

One of the things that I like about Holly Energy Partners is that the company’s revenue stream looks safer than that at some comparable pipeline and energy infrastructure master limited partnerships. Standard & Poor’s notes that 100% of Holly Energy Partners’ revenue is fee-based so that revenue isn’t dependent on either energy priced or energy volumes. Most of these long-term 10-15 year contracts come with minimum revenue guarantees that include annual rate increases based on increases in the Producer Price Index.

So if revenue is so safe, why the 5%+ yield? There’s very seldom a free lunch in investing—although there are mis-priced lunches.

And I think that’s the case here. Holly Energy Partners has depended on the drop down of assets from HollyFrontier for growth. That pipeline of assets that Holly Energy Partners can buy from HollyFrontier looks about empty with Holly Energy Partners acquisition of HollyFrontier’s 75% share in the UNEV Pipeline partnership.

But I think worries about a lack of future growth projects are overstated and ignore the growth opportunities that come from being located at the heart of the U.S. mid-continent energy boom. That boom has produced plenty of oil and natural gas but that production has come in a region with a relatively paucity of energy infrastructure from refineries (Holly Frontier’s business) to pipelines, collection systems, storage tanks and the like (Holly Energy’s business.) The drop downs may be running out but there are still plenty of investment opportunities for Holly Energy. The relatively small size of Holly Energy Partners means that small projects—say, to create infrastructure in the Permian and Niobrara fields—add enough revenue to make them worthwhile for Holly Energy Partners.

In April Holly Energy Partners raised its distribution to 47.75 cents, a 6.7% increase from the split-adjusted distribution in the first quarter of 2012. Wall Street projects that earnings per unit will grow to $1.47 in 2013 and to $1.60 in 2014 from the $1.29 earned in 2012.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of HollyFrontier or Holly Energy Partners as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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