MLPs That Grow on You

03/09/2012 11:45 am EST

Focus: INCOME

Roger Conrad

Founder and Chief Editor, Capitalist Times

Master limited partnerships are in the energy industry’s sweet spot thanks to low borrowing costs and big profit opportunities, says Roger Conrad, editor of Utility Forecaster.

Roger, MLPs became attractive to a lot of investors because of the dividend yield. Do you see that continuing going forward?

Well, dividend yields are a little bit less than they’ve been in previous years.

When we launched our MLP Profits advisory, it was the middle of 2009. Everything was pretty cheap. Many of these MLPs were yielding 7%, 8%, 10%—and of course they’ve done very, very well since.

So those current yields have come down, even though you have companies like Enterprise Products Partners (EPD) increasing their dividend every quarter. In fact, they’ve done that for 30 consecutive quarters.

My opinion about MLPs is that they’re in the sweet spot as far as business goes. Capital costs have never been lower; that means not only can they issue debt at lower rates than ever—it makes it not so great to buy bonds because the yields are so low. But they can issue this money very cheaply, borrow very cheaply, they can also issue equity or stock at very low rates. So that means they can raise pretty much all the capital they want.

There’s a tremendous number of new projects out there or potential opportunities to invest this money. It goes back to the fact that we’re unlocking tremendous reserves in the US of shale gas, natural gas liquids, and even light oil. The United States is now an exporter of energy. I didn’t think, that was something I didn’t think I’d ever see in my lifetime.

It’s a very, very bullish situation, and these MLPs are really tapped into it. They can basically go sign on, particularly…say, a pipeline company, sign on a bunch of companies to the pipeline before they even have to start it up, or before they even have to raise any money or start digging on the project. So that’s a tremendous benefit.

I think we’ll know there’s a top in the offing when you start seeing companies building pipelines speculatively—in other words, building before they have customers locked in—but that’s not the case now, and it doesn’t look like it’s going to be the case for a while., So they’re in the sweet spot.

What investors need to watch out for is valuation, and that’s because we’ve had about a two and a half year, really nice run in these things, so the yields are little lower. You want to make sure that the companies you own have the ability to continue growing and justify that high price.

Also, there are some environmental concerns. I think those have been mostly settled in many of the states, but you want to know where your companies are operating, and what sort of restrictions they’re subject to. If a state should ban hydraulic fracturing, for example, the producers would be the most effective. A company building a pipeline into that area would also be very much affected, because obviously there wouldn’t be anything coming out.

So you want to make sure you know those types of questions. I think like I say most of the legislation seems benign, but again it’s very much a state-by-state issue at this point.

Then there’s also the question of taxation. We get this a lot. MLP Profits people want to know if there’s a chance Washington is going to put a tax on these MLPs, just like Canada did with the Canadian trusts four years ago. But I think there’s a tremendous difference between the MLPs and the trusts.

For one thing, they’re a much smaller part of the market. The entire Alerian MLP Index has a lower market capitalization than the 50 largest MLPs, has a lower market capitalization than Exxon Mobil (XOM). So it’s very much a fly speck compared to Canadian trusts, which were over 20% of the market when they pulled the plug, and it looked like some of the bigger companies were going to do the same.

It’s not a big money tree for that reason. If you tax them, as ordinary dividends or if you tax them at the entity level, you’re not going to save a lot of money from that. They’ve also been a very effective lobbying organization, which really counts when it comes to federal legislations. So I don’t think this is something that investors should worry about.

Just one more point about it: if you look at the Canadian trusts that were in the pipeline business, in the energy infrastructure business, most of them converted to corporations, or a couple stayed partnerships and absorbed a new tax. But there has not been a single dividend cut in that group. They were able to start paying taxes, continue growing and not cut dividends. In fact, many of those are increasing them now.

So even if the worst case happens, naturally people panic in those types of situations. You might see lower prices. But these energy infrastructure companies are still going to be very solid and very bright futures.

Once we get through the churn, the same thing will happen to them as happened to the trusts, which actually along with MLPs have been one of the top-performing dividend paying groups since the recovery began in early 2009.

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