by Travis Johnson, Stock Gumshoe | June 20, 2012 11:55 am
CORRECTED — I originally published this article with the wrong solution, due to, well, simple idiocy as I wrote the wrong ticker down and didn’t backtrack to check myself. Many apologies if I confused anyone, the revised article follows:
Sheesh, just using the phrase “rich uncle” is probably enough to get my message to you today clogged up in a spam filter somewhere — but such is the plight of an ever-vigilant Gumshoe. How can we explain what the teasers and toutsters are talking about, after all, without borrowing their words?
This one’s from the folks at MLP Profits, which is team-edited by ELliott Gue and Roger Conrad over at Investing Daily … and that immediately focuses the mighty power of the Thinkolator on just one little sector of Master Limited Partnerships. But of course, even within that group there’s a pretty wide variety of stocks — mostly in the energy infrastructure business other than a few oddballs (cemeteries, asset management, amusement parks), but varied in the quantity and type of assets they own.
So which MLP is Gue touting today? Well, as implied in our borrowed headline above, it’s one with a “Rich Uncle.” Here’s how Gue gets our tease going:
“Income investors: Meet Your New “Rich Uncle”
“Wouldn’t you love a rich uncle who sends you big, fat checks, lavishes you with expensive gifts and guarantees your financial success?
“Guess what? Finally, it’s your turn to enjoy the ‘rich uncle experience’…
“Your rich uncle experience starts with a company my colleague Roger Conrad and I believe is one of the shrewdest, best-run outfits in the entire energy sector.
“The way this company operates makes every investor feel as if a wealthy benefactor is looking out for their financial future.
“By the way, this superb investment is not a stock, but a Master Limited Partnership (MLP). That makes this rich uncle experience even better. I’ll tell you more about these unique investment vehicles later.
“As I write, this whip-smart company is rewarding its investors to the tune of a delightful 8.4% distribution yield—which, as you know, beats the daylights out of the measly returns these days from Treasuries, CDs and S&P corporate dividends.
“Here’s Where It Gets Even Better…
“When you own shares in this brilliant outfit…
“… you’ll instantly become a lucky ‘nephew’ of a successful general partnership that lavishes your MLP (and by extension, you) with valuable, profit-generating assets.”
Now, I wouldn’t presume you to be a “lucky nephew” — of course that’s the way to play the odds when you’re writing to the crowd of potential newsletter subscribers, in an industry that generally targets upper middle class white men who are well into their red convertible years. And I suppose you may well fall into that group as well, since I can’t see you from here, but our wild guesses about the Gumshoe readership tell us that we’ve a fair number of lucky nieces in the group as well. Still, lucky is lucky.
Who, then, is this great rich uncle of ours? Well, the basic idea is that the General Partner (the company that runs the master limited partnership) is the uncle, and the lucky nephew is the publicly traded MLP that enjoys the General Partner’s largesse — here’s how Gue puts it:
“You see, my top MLP recommendation is sponsored by one of the most experienced general partnerships in the most active wealth-building energy sectors of the entire U.S. These sectors, by the way, are redrawing the global energy map.
“This major-league sponsor owns and operates an incredibly diversified portfolio of assets involved in the gathering, transport, storing, processing, treating and selling of crude oil, natural gas and natural gas liquids (NGLs). And best of all…
“They regularly reward their MLP (my top pick) with prized “drop-down” assets—those valuable “gifts” I mentioned above.
“It works like this…
“The best general partnerships (GPs), after acquiring new companies or facilities, will often pass along—or “drop down”—some of the prime assets to their MLPs. They do this to grow the MLPs’ distributable cash flow, which makes them even more rewarding and attractive to investors.
“Typically, a GP will drop down assets to their MLP at exceedingly advantageous prices, enabling the MLP to boost its distribution payments to investors. The best GPs also help their MLPs finance acquisitions. To top it off, they provide leadership and direct financial support when business or market conditions warrant.
“Of course, the general partnership doesn’t perform these functions out of charity. When the MLP (thanks to drop-downs) is able to boost its payout to investors, the GP also receives a larger share of the cash flow. Everybody wins.”
So that’s the idea — MLPs, given their constraints (they can’t retain earnings — not that they want to), sometimes need a bit of help growing, and that help is provided by their General Partner (GP). These General Partners also come out just fine in the bargain as they usually own a large piece of the MLP and they also get incentive distributions once they lift the MLP’s payouts above a certain level. MLPs have also been used to offload assets over the years, enabling the General Partner to sell expensive long-lived assets (like pipelines) and get those assets and their debt off the books but maintain control over them. A pipeline that generates a small amount of real income (after depreciation and taxes) for an oil company is not an exciting asset that boosts investor returns, but one that generates huge amounts of cash flow and distributes that cash to shareholders and effectively gives the shareholders the benefit of that depreciation writeoff in the form of deferred taxation creates an income investment which, at times, draws tremendous investor interest (MLPs have been around for almost 30 years in their current incarnation, but they do go through waxing and waning waves of faddish popularity).
And yes, this is one of those times of great investor interest in MLPs — after all, they typically have distribution yields of 5-9%, which looks dramatically better now with 10-year government bonds yielding less than 2% than it did a few years ago when those “risk-free” assets were yielding 4% or more. So while the yield is actually a bit below average on some of the big MLPs now (most average 5-6%), it’s still higher than the average income from many of the alternatives like utility stocks (under 4%) or real estate investment trusts (REITs, just over 3%).
Which one, then, is being teased by Elliott Gue as his favorite today? A few more hints, if you please:
“Here’s a recent example of a superbly advantageous drop-down I fully expect to spur growth in my favorite MLP’s cash flow… paying off in a generous boost to their already-substantial distribution payments.
“In this instance, the general partnership acquired a big-time energy transport company in the Southeastern U.S.—a company with key assets linked to two major, unstoppable energy-consumption and energy-transport trends.
“Shortly after acquiring the company, the GP announced a drop-down of a key asset acquired in the deal to my favorite MLP—that being 50% ownership of a strategically located gas pipeline at a very favorable price. (Translation: They virtually gift-wrapped the company with a bow on top.)
“This will be a great score for my top MLP pick because the southern states are way out front in the Big Switch from coal-fired power generation to gas-fired power—an historic changeover that’s going unnoticed by most investors….
“… my top recommendation is set to benefit from a key pipeline system that has a capacity of 3 billion cubic feet per day and supplies nearly two-thirds of the natural gas sold in the whole state of Florida….
“Sources whisper the general partnership is currently integrating the rest of the impressive assets acquired in this deal. I look for even more high-value asset drop-downs to my top MLP pick… and soon, at that….
“All this comes your way with a single investment in a company that’s built a reputation as a ‘virtuoso’ at moving oil and gas around the country—especially processing gas into the NGLs that petrochemical companies are buying hand over fist.”
And though that’s probably enough fodder for the Thinkolator, it’s worth tossing in one last juicy hint about a recent acquisition …
“The Virtuoso is Poised to Become the Maestro
“The MLP’s bold CEO recently announced their most audacious deal yet, a $5.3 billion cash and stock purchase of a major refining, marketing and logistics company that also operates nearly 5,000 retail fueling stations in North America.
“Here’s the inside scoop: Although selling these retail outlets could fetch up to $1.8 billion from any of the gaggle of companies already interested, this mega-deal isn’t really about gas stations.
“It’s about mega-lucrative midstream assets and NGLs.
“The deal immediately adds a wealth of oil- and liquids-related transportation assets—including 2,500 miles of refined-product pipelines and 5,400 miles of oil pipelines, plus terminals capable of holding 42 million barrels—to the firm’s rich portfolio of assets.”
So … into the Thinkolator it goes, hyperbole and all. And what answer comes pouring out the other side, nice and clean? This is … Energy Transfer Partners (ETP)
Which is pretty well a certain fit, particularly if you throw in that most recent acquisition announcement — which is that they’re buying Sunoco to build up their oil business (ETP is very much a gas and NGL company right now, Sunoco would add oil refineries and pipelines and, of course, the huge retail gas station network).
Sunoco is one of those refiners, by the way, that’s been suffering from the Brent/WTI spread that we’ve covered a few times — they are largely an East Coast refiner, so they get a lot of their oil imported via tanker, which means they pay more for the oil than does a mid-continent refiner with pipeline connections to Canada and North Dakota. That’s part of the reason why they’ve shut down one of their refineries and have been trying to restructure or sell others.
So … Energy Transfer Partners is a gas-focused and NGL-heavy MLP (lots of gas refining and processing and gas pipelines) that’s trying to get more oil exposure. And though they are hurt by some degree by cratering prices for natural gas, it’s not as bad as you might imagine. They lose business when their gathering pipes aren’t filled because wells get shut in due to low prices (as has happened in the Marcellus and Haynesville shale in some cases, for example, at least temporarily), but when low prices spur increased consumption by utilities or industry the throughput in their pipes can increase. The pipeline ownership part of the business is generally a “toll road” business that charges by cubic foot or barrel transported, not by the value of the transported gas or oil … so some parts of their business are weak, but it’s not like you’re buying Chesapeake Energy (CHK) or another of the highly leveraged gas producers that’s in trouble.
ETP is a large MLP, but not one of the top few biggest ones — it’s about half the size of giant Kinder Morgan Energy Partners (KMP), and similar to rapid grower ONEOK Partners (OKS), with a yield that’s substantially higher than most of the MLPs at about 8% — I think we can blame that on the fact that they’re . Their NGL mastery gives them a pretty big niche where they’re a strong player, though they’re far smaller than fellow NGL-heavy MLP Enterprise Products Partners (EPD), and NGLs have been hot over the last couple years as folks look for the gas-focused names that produce the far more valuable liquids (NGLs, like propane and butane, generally trade more in sympathy with crude oil than with natural gas).
There’s a certain logic to sticking with the big guys when it comes to MLPs — it’s relatively difficult to predict cash flow or performance for specific gathering systems or pipelines if you’re not pretty knowledgeable about the business or willing to follow it very closely, so the smaller companies that are more dependent on a few pipelines can be a bit riskier. I tend to like larger and more diversified names, and though I don’t own any MLPs right now I would probably look at a basket of the larger players if you want the tax benefits of ownership (like OneOk (OKS), Kinder Morgan (KMP) and Enbridge (EEP) in addition to ETP and EPD, for example, though I haven’t researched any of those closely), or the MLP ETF if you don’t want to deal with the K-1 partnership tax forms (I’d probably go with the Alerian MLP ETF, AMLP, but there’s also the Global X offering in this space, MLPA, and a new one from Yorkville, YMLP, that’s more focused on the producing MLPs like Linn Energy or Terra Nitrogen that are much more directly driven by commodity prices).
And yes, if you’re curious about that “Rich Uncle” bit, all MLPs do have a General Partner who runs the business — and sometimes you can even buy shares of the General Partner, like Kinder Morgan (KMI) instead of Kinder Morgan Partners (KMP), or ONEOK (OKE) instead of ONEOK Partners (OKS) — you generally get a lower yield but, in some cases, a faster growing yield if the MLP has grown fast enough to reach the “incentive distributions” level and get a higher share of the payouts from the limited partnership.
In the case of Energy Transfer Partners, the GP happens to be also publicly traded, that’s Energy Transfer Equity (ETE), which is indeed in the business of “dropping down” assets to ETP (including those Southern gas pipelines that ETE bought in their deal to acquire Southern Union, that Florida-exposed pipeline operator teased) … and they also are the general partner of another MLP, Regency Partners (RGP). They may well see distributions increase more quickly than at the MLP, and ETE actually has a decent yield for a General Partner at better than 6%, so it may be worth taking a look at those as well if you’re more interested in dividend growth than in current income (6% ain’t bad for current income, to be sure, but it’s a hair off the MLP’s 8%).
Personally, in looking at this complex web (ETE and ETP, then adding in RGP and Sunoco and Sunoco’s own MLP — or at least the General Partner shares of it), I keep thinking that ETE stands to come out of the whole thing very well, with lots of GP holdings in some solid second-tier MLPs and a large share of ETP limited partner units as well. For me, a 6% yield that’s been growing nicely is more impressive than an 8% yield that’s been pretty stagnant, though it may well be that, as they promise, ETP is turning things around and will be able to boost their yield as well. For what it’s worth, the two companies are roughly the same size at about $10 billion, though ETE’s potential red flag is that they carry a lot more debt than does ETP — though debt doesn’t cause me to panic with the valuable assets these companies control, and the balance sheets will probably shake out a bit as the Southern Union and Sunoco swaps and switches go through.
So what do you think? Is this the kind of “drop down” asset owning company you’d like to own in your portfolio for a 8% yield, or do you have another that you prefer, whether ETE or someone unrelated? I know that a lot of Gumshoe readers are active MLP investors, so feel free to shout out your opinions with a comment below.
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