4 Reasons to Buy This MLP

06/26/2013 9:45 am EST

Focus: MLPS

Charles Carlson

Editor, DRIP Investor

MLPs have been giving investors handsome returns, and the fun isn't over yet, writes Chuck Carlson of <a "target=_blank" href="http://www.newsletters.forbes.com/DRHM/store?Action=DisplayProductDetailsPage&SiteID=es_764&Locale=en_US&ThemeID=36003000&Env=BASE&productID=10294300">DRIP Investor.

The search for yield has pushed many investors into a number of investment "alternatives" to stocks. One popular investment alternative that has seen huge investor interest are Master Limited Partnerships (MLPs).

Because of its structure, an MLP does not pay income taxes. Rather, income, depreciation, and expenses are "passed through" to partners (i.e. unitholders), based on their ownership stakes. The unitholders, in turn, are responsible for their own tax reporting.

MLPs distribute the bulk of their cash flows to partners. Thus, yields tend to run well above those of common stocks, which is the major attraction of these investments. However, high-yielding MLPs are not a free lunch:

  • MLPs are sensitive to interest-rate movements. Because of their high income streams, MLPs can behave similarly to fixed-income investments, falling in value when interest rates rise.
  • MLPs rely on credit. Many MLPs in capital-intensive sectors—such as energy distribution and storage—must access credit markets to fund expansion. If that access is impinged—as happened during the 2008 credit meltdown—MLPs could suffer. Indeed, many MLPs were roughed up badly during the 2008 market downturn.
  • MLPs are vulnerable to economic downturns. Economic weakness affects end-user demand for energy products, which impacts MLPs volume and revenue. That could lead to lower cash distributions.
  • MLPs' unique structure can create some tax headaches for investors. Because of their structure and nature of distributions, profits taxable at ordinary income rates make up about 20% of the typical MLP's distribution, with the rest classified as return of capital. MLPs report tax information to limited partners via annual K-1 statements. If any of you have ever received a K-1, you know these are not the easiest documents to decipher come tax time.

Have these negatives kept investors away from MLPs? Not by a long shot. In fact, for the five-year period ending March 31, MLPs as a group produced total returns four times greater than the S&P 500 Index.

Among the MLPs that offer dividend reinvestment plans, my preference is Brookfield Infrastructure (BIP). I own these shares. They were spun off to me by Brookfield Asset Management (BAM), a Canada-based company that I have owned for a number of years. Brookfield Infrastructure engages in the utilities, transportation, energy, and timber businesses.

The company operates a port facility in the United Kingdom, electricity transmission lines in North and South America, electricity and natural-gas connections in the United Kingdom, New Zealand, and Columbia, and toll roads in Brazil and Chile.

The units yield 4.4%. The stock has performed well in line with the rest of the group, but offers a nice play in the MLP space.

You must be a holder of Brookfield Infrastructure shares in order to enroll in the distribution reinvestment plan. US investors may participate in the plan, which allows participants to have their cash distributions reinvested to buy additional shares.

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