MLPs: What They Are & The Best 3 MLPsApr 09, 2021
Upon seeing the title you may be wondering to yourself what is an MLP (master limited partnership) and why should I care? If you know what it is, please move to the next section. If not, we're here to help explain it!
MLP's are a business venture that exists in the form of a publicly traded limited partnership. They combine the tax benefits of a private partnership—profits are taxed only when investors receive distributions—with the liquidity of a publicly-traded company. MLPs are situated to take advantage of cash flow, as they are required to distribute all available cash to investors.
To maintain their elite status, MLP's are required to have 90% of their qualifying income realized from the exploration, production, or transportation of natural resources or real estate. The major takeaway from this is that because of the tax purposes, investors are not taxed when receiving dividends. The earnings are tax-deferred until you sell your share and at which point it gets taxed at a lower capital gain rate.
While everyone today is enamored with swing trading, what most do not realize is that on these trades, you pay taxes at your normal income tax rate. Therefore short-term trades become riskier as you need a much higher yield to beat out the lower federal income tax rates for long-term investors!
Now that we understand what MLP's are and why their tax status makes them important, let's talk about why we like the asset class and what MLPs we specifically like.
Why we like them:
- Outside of the tax benefits discussed above, they have extremely high dividend yields. The dividend yield shows how much a company pays out in dividends to each general partner each year relative to its stock price. So if a company pays out $10 and has a stock price of $100, the yield is 10%. Why is this important? Because dividend yields can drive returns without the stock price moving. If the market averages 10% a year for the last 50 years (it has), then with high-yielding investments like this, we can earn the same return, on each investment before any potential stock price appreciation!
- Not only do they have an extremely higher yield, but they also come with significant price appreciation potential now more than ever. This is because we've seen oil prices start to recover, thanks to the teamwork of OPEC and rising inflation. While the MLP business model is unique from other energy sector stocks, given their fee-based model, they've also participated in the energy infrastructure’s recent rally. Factor in MLPs strong free cash flow, discounted valuations, and a global macro recovery, and we see strong movements coming from MLPs in the near future.
The following are our favorite 3 MLPs (in no order):
- Philips 66 Partners (PSXP) 11.5% Dividend Yield: Their primary business objectives are to generate stable and predictable cash flow and increase their quarterly cash distributions per unit over time. They intend to accomplish these objectives by executing the following strategies: focusing on fee-based business, maintaining safe operations, growth through M&A and optimizing existing assets, and pursuing more organic growth opportunities. Long story short, PSXP is one of our favorite MLPs out there as they're truly focused on optimizing their business distribution while steadily growing and providing a stable, large dividend at 11.5%!
- Enterprise Products Partners LP (EPD) 7.7% Dividend Yield: EPD is an American midstream natural gas and crude oil pipeline company with headquarters in Houston, Texas. The company ranked No. 105 in the 2018 Fortune 500 list of the largest United States corporations by total revenue. EPD is an MLP investment monster, who is still looking to grow heavily. Increasing the yield and amount distributed on their annual report every quarter since 2016, EPD is generating serious cash flow and distributing it to shareholders! This is another must-hold MLP investment.
- Sunoco LP (SUN) 10.8% Dividend Yield: SUN distributes motor fuel to convenience stores, independent dealers, commercial customers, and distributors located in more than 33 states at approximately 10,000 sites. With a global re-opening underway and people resuming driving, SUN is in a good position to capture significant market share as they distribute their products to all Americans.
Bonus: ALPS Alerian MLP ETF (AMLP) 9.34% Dividend Yield: AMLP tracks the Alerian MLP Infrastructure Index. The Alerian MLP index is a composite of energy infrastructure Master Limited Partnerships (MLPs) whose constituents earn the majority of their cash flow from midstream activities involving energy commodities.
- If you don't want to pick individual investments when MLP investing, this is a good way to get broad exposure to the industry. With inflation rising, energy prices going up, and Biden's infrastructure plan being reviewed, this will benefit greatly from all three of those tailwinds.
- Additionally MLPs, along with energy sector prices, have been selling off for years. This could be a great opportunity to catch the rise of an industry that has been on a downswing for years. Please see the below chart for your reference.