Good Payoff for Disciplined MLP Investors

05/14/2012 11:00 am EST

Focus: MLPS

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Don't just find the highest-yielding MLPs and jump in, says Elliott Gue. Instead, look at potential for growth as well, as he explains by sharing a couple of recommendations.

We're talking master limited partnerships with Elliott Gue. How are you doing, Elliott?

Good, how are you?

Good, good. There's been some talk that a lot of these highly attractive high-dividend stocks, particularly MLPs and some of the other double-digit yielders out there, have been overbought. Or that this isn't really the time to be getting into them, that everybody has piled in, and now there's nothing that they can do to beat expectations. Where do you come in on this, and are there any opportunities left out there?

I don't think the sector as a whole is overvalued. What I look at when valuing these things is really comparing their average yields to the yield on, say, a ten-year US government bond.

The ten-year bond is currently offering a yield of less than 2%. On average, your average MLP is offering a yield more like 5.8% or 6%. Some are offering 10% plus. Others are offering 4%...but that's the average. If you look at that, that's a considerable advantage there.

It is about average for what we've seen over the last decade. They are really kind of average valuation. I think there are pockets of overvaluation at times, when people get a little bit too excited about an individual MLP. If you see an MLP—a lot of which are in very stable, sort of not real growth businesses, but more just stable cash return—if you see it go up 20% in the space of a few weeks, it may be that it's getting a little ahead of itself.

My suggestion is to stick with your discipline. Establish a buy target that you're willing to pay for a particular MLP based on what yield you think it should give. A more aggressive MLP should yield more than a stable MLP, big MLP.

And stick to it. Don't be tempted to chase it. You will get opportunities over the course of this year where MLPs will drop.

Sometimes when they do a secondary offering of units, meaning more shares basically, they'll drop in the aftermarket; but they use the cash they raise to fund acquisitions or new projects that allow them to then boost their distributions. Those can be great opportunities to buy, when you get that knee-jerk sell-off after the new unit offering.

Last August, we saw the market kind of unravel. People were worried about Europe. Some of these MLPs got hit for no fundamental reason; just because everybody was selling stuff. That's a great time.

My suggestion is put a little bit of money to work now if you want to, then a little bit of money to work in a few months' time. Split your investment and save some dry powder for those dream sell-offs that we get every year at least a couple of times.

It sounds like what you're saying too in your strategy, it's not necessarily chasing the giant yields either. That you can find a good solid 5% to 6% that's in a stable business that might not be too exciting, but it's a lot better than parking your money in cash or hanging out in Treasuries or something along those lines.

Right. There's very few yield alternatives that yield anything close to that 5.8% average MLP.

One of the biggest mistakes I see individual investors make is to sort of run their finger down the yield column and pick the highest yielding ones. Typically, an MLP that offers a 10%-plus yield probably has commodity price exposure. That's one thing.

It can get hit when we have concerns about global growth...and the market has been incredibly volatile in recent years. You have to be prepared for that. In exchange for that 10%-plus yield, you might have a lot of volatility.

Others have very little distribution growth potential. I like to look at their dividend yield plus growth as sort of a basis. In other words, if they're yielding 6% and growing a distribution at a 6% average annualized pace, I look at that as 12%. That's very attractive.

Something above 10%, 11%, 12%...look at that as well. Don't just look at that yield. Look at their potential for growth. A lot of those 10%-plus yielders are going to be stagnant. They're very close to not meeting their distributions, and they're going to have a tough time raising them as a result. It's very important not to chase yields.

Real quick, give me a ticker symbol that exemplifies this.

Well, one of the companies I like a lot is Teekay LNG Partners (TGP). They own LNG carriers, which are used to transport natural gas over long distances over water.

Another one I like a lot is one called Genesis Energy (GEL). This company also has an above-average yield, 7% plus. They've increased their distribution for 26 consecutive quarters. Absolutely reliable grower.

They are involved in a lot of oil storage, oil terminals, oil related infrastructure. A very stable business and long, long track record of growing their distributions over time.

Related Reading:

Energy Trusts a Reliable Gusher

Big MLP Comes Under Post-Earnings Fire

Why I Like MLPs

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