by Travis Johnson, Stock Gumshoe | October 18, 2012 1:05 am
I guess we should really be calling this “A.O.P. 2.0”, since the Stansberry folks used this same basic marketing pitch on investors about five years ago — though I think that was in service of their S&A Resource Report (then called the S&A Oil Report), and this one is an ad for the relatively conservative, dividend growth-focused 12% Letter edited by Dan Ferris.
And don’t worry, we’ll check and see whether any of their “AOP” investments are the same as they were five+ years ago … though I suspect it’s just the intriguing “American Oil Pension” concept that they’re rehashing and they’ve probably pegged some new plays on this theme.
The basic idea is that there’s an “income plan” that you don’t know about, but they can tell you if you sign up for their newsletter — here’s the quick spiel:
“Over the last 15 years, a little-known ‘income plan’ has outperformed the stock market, beating every asset class we know of – with annualized returns of 16.6%.
“In November 2012, we expect A.O.P. recipients will receive their largest payout to date… here’s how you can get on the recipient list now.”
I could go through and quote chapter and verse from the ad to give you the whole rundown on this history of the “AOP”, the reasons it exists, the great historical returns that investors have seen in these investments, etc., but it’s easier just to cut through the chatter and tell you that yes, “A.O.P.” is just Stansberry’s made up name for … “MLP”.
Master Limited Partnerships (MLPs) are an important part of the energy infrastructure of the United States — they are tax-advantaged vehicles set up (usually) to own and receive the cash flow from pipeline and midstream energy businesses, which includes everything from the gathering systems that pull gas and oil from individual wells to the huge interstate pipelines that move oil from Louisiana to New York to the processing plants that refine natural gas.
And I expect most Gumshoe readers have heard of MLPs — with high dividend yields that are generally in the 5-10% range (depending on size, perceived risk, etc.) and with a built-in tax deferral, it has not escaped notice that you get a lot more cash flow back from MLP investments than you do from most income investments. They can be somewhat complicated to deal with, particularly when it comes to taxes, and they run the gamut from “blue chips” to risky little guys that are just shy of being scams, but the larger MLPs that most of us have heard of — Kinder Morgan, OneOK Partners, Boardwalk Pipeline, Enterprise Product Partners, Williams Partners, El Paso Partners, Magellan Pipeline Partners, etc. — have almost all been teased at one point or another over the last half-dozen years.
So let’s see if Ferris has some kind of new twist on this investment, and find out if we can determine specifically which of the MLPs (sorry, “A.O.P.s”) he’s recommending to his subscribers. Ready?
“In 2006, we detailed an obscure income opportunity we now call the “A.O.P.”Are you getting our free Daily Update
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“Born out of two Reagan-era tax reforms and made possible by a collection of vital U.S. businesses, the A.O.P. has outperformed every investment we know of…
“It has beaten the S&P 500, the Dow Jones Industrial Average, Utilities, and REITS — with 16.6% annualized returns.”
That’s more or less true — MLPs have substantially outperformed the stock market not just over the last five or six years, but going back 10 or 15 years now (over the last two years MLPs on average have done almost 20 percentage points worse than the S&P 500, though . Their consistent cash flow has been a real boon during times when the market crashed, though they’ve often underperformed during rising markets and, of course, whether or not they worked out well for individual investors along the way depends on whether you bought at low prices (many MLPs did fall 50% or more during the stock market crash). And over the past couple years they’ve probably gotten more attention from investors than at any time since the asset class was created during the 1980s as a way to spur energy infrastructure development (following the OPEC embargo and oil crisis, as you might remember).
The idea is that these are necessary infrastructure companies, sort of like utilities for the broader economy, which will need easy access to oil and gas well into the foreseeable future — but that there’s a catalyst that might be underappreciated in what several other Stansberry publications have talked about (and others have touted too, of course) as the great industrial revival brought on by another cheap energy boom, particularly cheap natural gas as we work through the vast new supply streams brought on by hydrofracking and horizontal drilling innovations in recent years. Here’s a bit of Ferris’ take on that:
“… perhaps an even bigger catalyst for A.O.P. growth is America’s new gas boom…
“As you probably know, in just the past few years America has discovered vast amounts of natural gas thanks to a new gas-drilling technology known as hydraulic fracking.
“The Potential Gas Committee indicates that the U.S. now has a 90-year supply of gas. CIA Director James Woolsey, believes we have a ‘200-year supply of natural gas.’
“I can’t tell you which estimate is more accurate. But I do know that America no longer has to rely solely on foreign imports to meet its energy needs. Oil giant BP actually thinks the U.S. will get 94% of its energy domestically by 2030, up from 77% now.
“As expected, major energy companies like Clean Energy are building natural gas fueling stations all across America in order to meet new demand.
“But in order to operate these stations more pipelines are needed to transport the gas. In fact, according to Phil Blancato, CEO and President of an asset management firm in New York, ‘there is demand for $200 billion to $300 billion of new pipelines.’
“That’s why A.O.P. businesses are ripe for future growth…
“For one thing, these companies have little competition. Once a pipeline gets built most folks don’t want to see another one in their backyard. In addition, regulatory approvals for new pipelines are very hard to come by. So if you own a pipeline in a given area, odds are you won’t see competition for a long time. And if there’s a need for more pipeline capacity in that area, an existing pipeline will expand.
“And since these businesses charge set fees for transporting oil and gas, they are not directly exposed to falling commodity prices. They just produce steady income for years.”
OK, so that’s the basic big picture idea for “why MLPs are good” — we use energy, we need to transport it, and we’ll probably use more now because it’s cheaper — and these are toll businesses, the stocks move sometimes when commodity prices change, but they don’t own or produce the actual gas or oil so their actual revenue (for basic pipeline operations, at least) depends on the volumes that flow through their pipes, not on the precise price of the commodities. (Some MLPs do stuff other than run pipelines, including some producing MLPs that actually drill for oil and gas, and some take more commodity price risk than others — but for the most part they’re toll businesses who charge by volume and distance).
And, of course, there’s the promise of huge income:
“Collect as much as $68,000… or $125,000 a year – It’s Up to You…”
Well, I guess that’s true — if by “up to you” they mean “how much you want to invest and put at risk” — the average MLP yields about 6% right now, so you could expect those immediate income per year results if you invested between one and two million dollars. Which perhaps some of you can, but I’m afraid that’s a bit out of your friendly neighborhood Gumshoe’s tax bracket. Of course, if you pick MLPs that are above average and compound your earnings those numbers could certainly improve over time, but like any dividend-paying equity investment the initial income you receive would be based on the partnership’s current distribution yield and the number of units you buy. (That’s just an oddity of these kinds of investments — they’re not actually corporations, they’re publicly traded pass-through limited partnerships, so you buy a unit of the partnership and collect distributions, they tend not to use the words “stock” or “dividend,” though I’ve been known to jumble my terms from time to time).
Which ones, then, are the 12% Letter folks teasing this time?
“A.O.P. Company #1: One of these businesses is based out of Oklahoma and operates approximately 15,000 miles of interstate natural gas pipelines. Together the company’s pipelines deliver over 1/10th of ALL the natural gas consumed in the U.S. In fact, one pipeline transports enough gas in one day to serve the needs of more than 20 million homes.
“If you bought 1,000 shares of this A.O.P. company after the market crashed in the beginning of 2009, you would have since made over $40,000 in capital gains. You’d have received 14 distribution checks during that same time.
“If you’re looking for cash-in-hand, every few months, then you’d be hard-pressed to find something that pays out more to investors. Since this company went public in 2005, they have increased their payouts by 435%. I expect the company’s total assets to increase by more than 50% over the next few years as America rushes to exploit its new sources of natural gas.
“Like all A.O.P. businesses this company sends out distribution checks 4-times a year. The payouts typically occur during the following months: February, May, August, and November. So keep in mind, to qualify for these checks you need to become a shareholder about 10 days before the payout date.
“Every quarter the company announces exactly when you need to get in to qualify for the next payout and the exact date you can expect to get your check.”
Well, the reason that you could have made $40 a share in capital gains over the last two years is that this particular MLP got hammered far worse than the average during the financial crisis — most of these types of shares fell about 40-50% during the market crash in 2008-2009, but this one fell almost 80%. The MLP they’re teasing is Williams Partners (WPZ), the MLP spun out of their current general partner Williams Companies (WMB).
WPZ is one of the larger pipeline companies, and they own both interstate pipelines and gathering systems, as well as midstream and chemicals businesses. They currently have a distribution yield of almost exactly 6%, which is average, and, like many MLPs, they try to raise the distribution not just every year, but every quarter (not by a lot each time, but consistency counts — they froze the dividend for a year or so coming out of the market crash but otherwise raise every quarter). If the next payout matters particularly to you, the next quarterly distribution will probably be declared in the next two weeks and paid out right after Halloween, and it will likely be a bit over 80 cents per share (the shares change hands for about $55 at the moment).
As with many large MLPs, you can also buy shares of the general partner if you prefer — that’s Williams Companies (WMB), which will not generate as much current income but should have, if they’re set up like other MLPs, an incentive distribution that raises their share of the payouts once those payouts hit a higher level, so general partners usually have less debt and sometimes also have better dividend growth or more diversified businesses. Williams also spun out their exploration and production unit, MPX Energy (MPX now) last year, so their limited and general partner shares of WPZ are certainly their most important asset now. The general partner always has outsize control over the limited partners, and in this case that’s definitively so, Williams Companies has pretty much 100% control over the MLP.
If your argument is that natural gas demand will continue increasing because of the low prices for nat gas, which is part of the pitch from Ferris, then WPZ is probably a decent choice for that — they are leveraged to gas and to natural gas liquids (NGLs), which basically just means that they transport and process more gas than oil. They do have at least one “crown jewel” asset in the Texas-NY Transco pipeline, which is a critical interstate connection, and they get half of their revenue from these pretty consistent, long-haul, fee-based transport pipelines. They also have thousands of miles of gathering systems, also mostly for gas, and processing businesses that are levered to NGL pricing to some degree … which is probably why they disappointed a bit last quarter (lots of companies have sidestepped low natural gas prices by focusing more on natural gas liquids, but that has, somewhat predictably, brought down NGL pricing too).
And the second one?
“A.O.P. Company #2: The second A.O.P. business is based out of Texas and owns more than 20,000 miles of natural gas and natural gas liquid pipelines. It also owns several natural gas storage and distribution terminals and natural gas processing facilities.
“The company currently pays an 8% yield and has increased its distribution payouts by 257%.
“In addition, this company is currently acquiring another A.O.P. company that has a pipeline in the middle of one of the biggest oil discoveries in U.S. history.
“As with A.O.P. Company #1, this firm also sends out distribution checks in February, May, August, and November. Again, to qualify you need to become a shareholder about 10 days before the payout date. The exact date is posted on the company’s website every quarter.
“These are my favorite two A.O.P. businesses right now… the ones I believe will profit most from America’s burgeoning natural gas boom.”
This one, says the Mighty, Mighty Thinkolator, is Energy Transfer Partners (ETP), a very natural gas-focused midstream player, and another one of the large MLPs (market cap around $10 billion — Williams Partners is around $19 billion). ETP carries an above-average yield of over 8% because they’re a bit more levered than most, and because they haven’t been able to grow their distribution since the Spring of 2008. Analysts seem to think that, thanks in part to several acquisitions (including Sunoco, a merger they just finalized about ten days ago), they should be able to start growing the distribution again, which would probably be a catalyst for a bit of price appreciation. Their acquisitions have also given them, particularly in the case of Sunoco, more exposure to crude oil transport in addition to their strong gas pipeline business, so that could also help to stabilize the company. The merger with Sunoco was a big one, and Sunoco shareholders received a lot of ETP stock in the deal, so there is some chance that the shares are depressed because of selling pressure (if Sunoco shareholders didn’t want to be ETP shareholders) … and there’s also a bit of trepidation, I expect, about the fact that ETP will clearly have to do borrow money fairly soon, though their assets certainly offer quite a bit of collateral.
ETP is one that looks pretty appealing to me, largely because the fact that they’re a bit beaten down and have made acquisitions lately means that they have some potential to rise if they get revalued as just “average” by investors, but there’s certainly some risk in that they tend to have more natural gas commodity price risk (including NGLs) than the average MLP, and they have execution risk for this big merger and the need to refinance some of their abundant debt. If they can resume distribution growth from this level, that income quite quickly gets interesting since it’s already sitting at a 8.4% income yield, I don’t own any MLPs at the moment and haven’t been particularly eager to get into the space lately, but I expect I’ll be keeping half an eye on this one in the weeks to come.
It’s also worth noting, by the way, that, these stocks, not unlike other sectors, tend to trade in lockstep when big market events are happening, particularly if they’re bad market events — they only get individual attention and start to differentiate themselves when news is relatively good or placid, so if you expect oil to drop by 50% or think we’ll see a market crash, you could save yourself some effort and just buy an ETF or a basket of these stocks (sorry, I mean “units”).
The simplest way to do that is with the largest ETF for the sector, the ALPS Alerian MLP ETF (AMLP), which yields 6% and holds all the big names, but there are also closed-end funds (which usually have onerous expense ratios, currently typically trade at a premium to net asset value, and use leverage to goose their distribution but still, with a couple exceptions, have near-average yields of 6-7%) and an ETN available that also tracks the index (the JP Morgan Alerian ETN, ticker AMJ). There are also a couple other ETFs, including the Yorkville offering (YMLP), which owns more producing companies and riskier higher-yield offerings and yields a bit over 8%, or the Global XMLP ETF (MLPA), 6% yield, which is pretty similar to AMLP though with different weightings — importantly, the Global X offering (MLPA) has a much lower expense ratio than the larger AMLP, so it might be worth a look just for that reason.
As with all MLPs, you’ll typically have to file K-1 forms with your taxes since these are pass-through partnerships that distribute their cash to unitholders and therefore don’t pay corporate taxes, and you’ll owe taxes on the income that passes through to you (along with other potential tax headaches that frighten some investors off, but as far as I can tell don’t typically really matter for small investors, like the potential for generating enough income in other states that you’d need to file in more than one state) … but because of the magic of MLPs (they get to do a lot of depreciation, which isn’t a cash expense), they generally pay out to unitholders far more cash than they actually book in “earnings.” That excess cash is usually called “return of capital,” and in accounting-speak it just means that they’re giving you some of your own cash back, which lowers your cost basis but doesn’t generate taxable income immediately — since your basis is lowered with each payment, you have to keep track of that over time and you’ll owe taxes on the capital gains from that lowered basis when you sell the shares … which is why MLPs are often referred to as “tax deferred” investments, enjoy your cash flow now and pay taxes on it later.
Of course, if taxes are higher later on, when you sell, that’s less of an appealing advantage — but still, taxes you don’t have to pay today means more cash in your pocket today, or more cash that you can use to buy additional shares and compound your returns.
So that’s the basic rundown on the “A.O.P.” As I said, I don’t currently hold any MLP investments and would tend to lean toward ETP out of these two (though I think diversified baskets of MLPs are a safer bet), but I know a lot of Gumshoe readers do love these high-yielding fellas … so if you’ve got a favorite, or know of a reason why readers should (or shouldn’t) consider ETP or WPZ as “gas boom” plays, feel free to shout it out with a comment below.
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