Supercharge Your Wealth and Pay (Nearly) No Taxes!

By Travis Johnson, Stock Gumshoe, July 16, 2009

That headline comes from an ad for a new income-focused newsletter that is just launching now … Roger Conrad and Elliott Gue are starting a service that sounds quite familiar — they’re calling it MLP Profits, and it will be focusing, you guessed it, on Master Limited Partnerships. The publisher, KCI, tried to launch something similar a year or two ago with Neil George called The Partnership, but I guess it must not have taken off … try, try again!

I know a lot of my readers like Roger Conrad, and his Canadian Edge newsletter is highly ranked by the folks on the Stock Gumshoe Reviews site, so I thought I’d take a look and see what kind of picks he’s teasing for this MLP-focused newsletter.

If you’re not familiar with MLPs in general, I’ve written about them many times and they exist in any number of industries. The biggest group of them are in the midstream energy space, meaning they process, store, and transport natural gas, refined products, and crude oil, with the most well-known of these MLPs being the big interstate pipeline owners. They can be thought of as somewhat similar to Real Estate Investment Trusts, in that they don’t have to pay corporate taxes because they pass through their earnings to their unitholders, but they carry significant tax advantages for many folks beyond that (it’s a bit complicated, but because of depreciation a lot of the distributions are treated as return of capital, so you don’t owe taxes on them until you sell the units — I’m not a tax expert, and MLPs do require some additional recordkeeping and tax forms, so don’t rely on me for those details).

And MLPs exist in a lot of other industries as well — I even called folks’ attention to one of them, StoneMor Partners, as my Stock Gumshoe Irregulars “Idea of the Month” back in June, and aside from that cemetery owner there are MLPs that focus on horse racing, financial services, shipping, real estate, and fertilizer, among a few others, but those are outliers and oddballs — the vast majority are in the energy business in one way or another.

These vehicles got a bad name shortly after they were introduced in the late 1980s, largely because there were a bunch of them that were somewhat “scammy” and really designed just to be tax shelters, but they are very popular and usually well-respected now, and new rules allow mutual funds and institutional investors to hold meaningful positions in these partnerships as well, so there’s more attention for the sector.

Throw in (as Conrad does) the guess that the baby boomers will be looking for dividend income, or that the Canadian trust sector, a long-time favorite of yield investors, is seemingly losing popularity with their new tax changes for trusts, and there’s the chance that MLPs will gain in popularity, pushing prices higher, as those nearing retirement look for relatively safe, high yield investments.

Conrad claims that they’ll be covering all the MLPs in this newsletter, which would be a bit of a handful but not impossible (there are less than a hundred that I know of) … and he tells us that he’s got a few favorites to recommend right away.

Those are the ones your friendly neighborhood Stock Gumshoe is interested in finding, of course … so let’s see what clues he provides:

“Piping In Your Profits. This MLP owns a top-notch portfolio of extremely stable refined products — pipelines and crude oil terminals. So top-notch, in fact, that the stock is shooting up at more than nine times the rate of the S&P, with gains of more than 20% in the first half of 2009. And that’s on top of a current yield of more than 7%!

“The company’s refined products pipelines carry petroleum products like gasoline and jet fuel for which volumes vary very little, even including during the recent recession. They’re able to offset any decline in volumes there may be with higher tariffs, and they’re seeing even stronger growth in their terminals segment, which has been able to raise fees dramatically on older contracts coming up for renewal. And terminals are generally seeing high demand for ancillary services such as mixing ethanol and other additives to gasoline.

“They have strong growth projects too, including tank facilities, a pipeline between their Texas terminal and a massive refinery, and acquisition of a refined products pipeline in Texas from oil giant ExxonMobil. These should enable management to meet its goal of a 10 percent distribution hike later this year. All of which is a great reason for you to own this company now.”

That sounds like it must be … Sunoco Logistics Partners (SXL)

They did indeed just (eight months ago, that is) buy a refined products pipeline from ExxonMobil (the MagTex pipeline system, in Texas, and stated that it should be immediately accretive to their cash distributions. They were formed to buy Sunoco’s pipelines, but have expanded beyond that with big refined product pipelines primarily from Texas to the Midwest, and in the Northeast, as well as a cross-country crude oil pipeline and a lot of storage and crude transport assets in Oklahoma, the traditional center of the U.S. crude oil trade.

And that does make them a bit more stable than the folks who provide different services, like the gathering pipelines in gas fields (since those gathering systems are dependent on continued production from one field), and from some other partnerships that own assets that are perhaps less diversified — which is why they sport a relatively low 7.4% yield (that was a nice, high yield two years ago, when everyone loved MLPs and pushed the prices up, but it’s very low now — many relatively stable midstream MLPs currently yield 8-9%, though prices have been climbing in recent weeks and there are others in Sunoco’s league, like Magellan Midstream, that also have yields in the neighborhood of 7%.

And if that 7% doesn’t sound impressive, do note that, although there’s no guarantee of what will happen in the future, this MLP has raised its dividend every single quarter since it went public in 2002. That’s each quarter, not each year — other MLPs try to raise the distribution each quarter, too, but it’s still impressive.

How about some other ideas? Here’s one that he teases that has a much higher yield:

“Double Your Money. Not only is this MLP selling at a fraction of its 52-week high, its share price could double or better in the coming months since the company is sound and pouring off a river of earnings to unit holders.

“Even better, the stock is paying investors a current yield of over 13% right now, which you can lock in if you buy today.

“The company is a fast-growing producer of oil and natural gas from fields located in the Mid-Continent of the US and California. Their focus is mature fields that have reliable geology and therefore predictable yields and costs. That’s an ideal formula for paying distributions. Some of the company’s fields in California, for example, have been in operation for close to a century.

“They have about 1.7 trillion cubic feet of gas-equivalent reserves, with about half of the reserves being natural gas. Close to 70 percent are proved, developed reserves, about as certain as you can get in the energy business. It also has more than 4,000 potential locations for new wells on its existing plays to grow output when the time is right.”

That must be our old friend Linn Energy (LINE), which I’ve written about a few times — most recently when it was teased by Bryan Perry last month. My opinion about this oil and gas producer (this is a producing company, not a midstream company) hasn’t changed — I still regret not buying it when it was incredibly cheap earlier this year, and I didn’t convince myself to pick up shares when it was climbing to the current levels near $20. Though this is a gas and oil producer and therefore needs to replenish reserves, and otherwise is subject to pressures that pipeline owners don’t see, their claim to investor adulation is that they hedged virtually all of their production for the next couple years, which makes their current distribution, around 13% currently, very sustainable (assuming no calamities, of course — they still have to produce all that oil and gas that they’ve effectively pre-sold).

And one more, for old time’s sake?

“An Undiscovered Star. Try to find someone (besides me) who knows about this first-rate company and you’ll turn up a big zero. Which is great for us, because it’s a stock that every income investor should take a look at today. The company is not a producer of oil and gas, but instead is a small MLP that operates gas processing and gathering lines and small pipelines connecting individual wells to the pipeline grid.

“The MLP has some pretty substantial growth opportunities, too. A new pipeline with capacity of 1.1 billion cubic feet per day that will spirit gas from one of the country’s lowest-cost and highest potential natural gas plays. So large, in fact, that its projected reserves are five times the current largest US field.

“The company has one of the most attractive yields in the market—nearly 13%—that is generated from their solid and highly productive contracts. And with two financial heavyweights to back up their large projects, word of this undiscovered star is starting to leak out, which means the share price could skyrocket.”

Well, you can include me in the list of people who hadn’t heard of this MLP before — but I’m pretty sure he’s teasing Regency Energy Partners (RGNC)

They do have a 1.1bcf/day project coming online this year, it will be connecting the Haynesville Shale fields of Louisiana to customers, and that shale gas field is potentially one of the largest gas fields in the world. They are also very much a growth-oriented MLP, aiming to continue building capacity and adding services to their network — which means they have to invest more than someone who’s just maintaining and slowly growing their pipelines and gathering systems. Their dividend isn’t quite at 13% anymore, as the price has spiked up in the last week or two, but it’s still well above 11%.

I like most MLPs and own two big ones myself (KMR, not technically a MLP, and BWP), and I must admit not only that I still regret not buying Linn Energy, but that this Regency Energy Partners sounds pretty interesting. I’d guess that since they are so focused on natural gas, and that much of that focus is specifically on their expansion project for one field, they’re a bit riskier than the bigger and more diversified players, especially if additional shale exploration gets shut in because of low natural gas prices — but it is nice to own a high yielder with a growth focus, and they do have a strong general partner in General Electric (the general partner is the one who actually runs the business and takes a premium return, limited partners like MLP unitholders just take their share of the cash and sit on their duffs).

So what do you think? Are you hoping for another market crash to make MLPs crazy cheap again, or do you think they’re a good buy here? Or do you not like them and their K-1 tax forms at all? Let us know with a comment below. And if you’ve ever been a subscriber to any of KCI’s publications, like Personal Finance or Canadian Edge, please click here to review them for us and share your thoughts. Thank you!

Full disclosure: As mentioned above, I personally own shares of MLPs Boardwalk Pipeline Partners and Kinder Morgan Management, I do not own any other investments noted above, and won’t trade in any of them for at least three days.


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21 Comments on "Supercharge Your Wealth and Pay (Nearly) No Taxes!"

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AD
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July 16, 2009 12:28 pm

Don’t like the crazy mlp’s, but i own KMR and EEQ. Maybe at somepoint close to retirement will convert them to respective mlps to get the cash. Also holding them in my roth doesn’t give me the tax advantages the MLPs are supposed to offer over non retirement accounts.

AD
Guest
0
July 16, 2009 12:31 pm

Oh any by crazy MLPs i just meant the k-1 and the extra hassles, not the actual MLPs

Gravity Switch
Admin
11
July 16, 2009 12:37 pm
Thanks AD — for those who aren’t familiar with these two (I own KMR), they are “sisters” of MLPs and are themselves not technically partnerships. They pay their dividends in new shares, not in cash, and you don’t get the same K-1 reports and have quite the same tax headache — I think they were designed to be held in IRAs without the problem of large MLP positions generating taxable income within an IRA, but they’re also a nice way for folks who like MLPs but would just be reinvesting their dividends anyway to get exposure with a bit more… Read more »
Al
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Al
July 16, 2009 12:45 pm

Where does the “NEARLY NO TAXES” fit
in with this discussion?

Edski
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Edski
July 16, 2009 1:00 pm
Al, from Conrad and Gue’s e-mail: And right now one of our favorite MLPs yields a nice 10.3% — and 90% of your income is tax-free. Try to find a muni bond as generous as that! You can stagger your payments to come in monthly—so it’s convenient to pay monthly bills. As an added bonus, your personal taxes are so low that you’ll think the IRS has gone soft in the head. Plus thanks to depreciation, 80% to 90% of the distribution you get from a typical MLP is tax-free until you sell. (In fact, some MLPs let you pocket… Read more »
Cool Soupy
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Cool Soupy
July 16, 2009 1:43 pm

Trying to dig out the effect of the change in Canada of the trusts to corporations in 2011 is like pulling teeth.

I subscribed to Rogers pub and lost money as he didn’t see the bottom coming.

KYE has a good basket of MLP’s and charges a reasonable management fee. It has been very good for my IRA portfolio with none of the MLP’s headaches.

Another very good canadian dividend stock for your retirement portfolio is Atlantic Power. They are a “fund” and not subject to a dividend cut in 2011. Their management feels that the dividend is safe through 2015.

Michael laen
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Michael laen
July 16, 2009 5:22 pm

Have you taken a look at the expense ratio of KYE?
Why on earth would I buy this CEF. You have to be kidding or must be working for them.

Gravity Switch
Admin
11
July 17, 2009 10:37 pm
It’s true, pretty much all the closed-end funds for MLPs (there are only a few others that I know of, notable the Tortoise ones) are pretty expensive, management fee-wise. There is one ETN for MLPs, the JP Morgan offering based on the Alerian index of energy MLPs — it’s a ETN, not an ETF, so you’re taking on credit risk that JP Morgan will be good for their commitment, but it does track nicely with the MLP sector and should pay a decent dividend. It has an expense ratio of .85%, still high for an ETN that tracks a tiny… Read more »
Randall
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Randall
July 31, 2009 11:11 am

Given the tax implications (the old K1 problem), I would just buy AMJ…..set it and forget it! Sounds like Ron Popeil, but seruiously AMJ should be a part of everyone’s diversified portfolio and you should throw in some precious metals etf’s as well. Maybe CEF or DBP 80% gold, 20% silver.

Good investing my friends!

Fabian
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Fabian
July 31, 2009 11:46 am

KYE; you can also check IRR, not LMP invested but also a play on energy. Distrib is about the same as KYE but premium is very low (0.5% vs KYE 11%). Fee is 1.25% ,it’s hedged and has no leverage.

Yieldmaniac
Guest
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August 3, 2009 8:35 pm

Another item to consider re: MLP CEFs is that they tend to be highly leveraged. This boosts your yield, but can cause problems if [when?] interest rates escalate. It is probably better to just buy a few of the better MLPs yourself. Unfortunately, it’s getting late for MLPs; the time to buy these things was in March or April. At this point most of them have under double-digit yields. Back then their yields were astonishing.

Maria
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Maria
August 28, 2009 9:57 am

Hi, Travis;
What’s happening with APL? I still hold them and hope they’ll recover…

john
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August 28, 2009 11:55 am

I have held Kinder Morgan for some time. They provide detailed forms showing where to move numbers in the K-1 to related places on 1040 and schedules – nevertheless very confusing – I took my results to a tax advisory service and they simply said they can’t do K-1 – so far my guesses have not been questioned by the IRS.
I bought LINN this year – indeed wish I had bought it years ago when Personal Finance first recommended it.

Lukeste
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Lukeste
January 17, 2010 4:39 pm
Hello all – I’m new here and have a question. I have a family friend who is retired and elderly. She’s just taken a very bad hit due to a complex investment mishap and is looking to reconfigure her income portfolio with some exposure to oilgas MLP’s. I’ve collected these names so far, to recommend to her, and wonder if members here would comment on which ones you’d all cherry pick out of this list as the most conservative plays. She and I both are very bullish on this space going forward the next five years – she just wants… Read more »
fireball
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fireball
January 23, 2010 8:53 am

bought clmt, pvr, mwe awhile back. very happy so far with them.
also had cmo for awhile but decided to take profit and get out because it seems vulnerable to interest rates.

Stanl
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Stanl
July 16, 2009 3:37 pm

Edski, As one just about retired, I am looking at ways to avoid some of the risk of stocks, but not to the degree that CD’s imply, i.e., maybe shifting some into TIPS, how does MLP’s fit with this line of thinking?, would you care to mention your favorite MLP.

Thanks,
Stan

Michael laen
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Michael laen
July 16, 2009 5:23 pm

Retire military here. Would you like to share the name of this MLP? I would very much like to buy some shares.

Lee
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Lee
July 16, 2009 6:53 pm

I agree, I do my own taxes but had to pay someone this yesr because of the K-1s!

stockcrazy10
Irregular
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stockcrazy10
July 16, 2009 7:45 pm

Most MLP websites have extensive tax information available online and reps to answer your questions.

The Investor Relations rep at LINN Energy assured me that TurboTax can handle the K-1s.

Cool Soupy
Guest
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Cool Soupy
July 18, 2009 8:53 am

Let’s see?

I am up 29.21% since purchasing this year.

I am getting a 13.75% return in dividends.

I will gladly pay the 1.9% management fee.

ps: If you have some better picks I would definitely be interested?

maryjane knight
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maryjane knight
February 19, 2010 7:11 pm

enjoyed your information
Where can I find a broker who will purchase
these funds . I a in US

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