One would think that with yield chasing investors increasing their exposure to dividend paying securities these days, the yields on energy master limited partnerships (MLPs) would no longer be attractive. Yet despite the nearly 50% rally in the MLP space this year, attractive yields still remain. (For a quick refresher, check out Discover Master Limited Partnerships.)
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What To Look For
Energy MLPs operate as partnerships that are exempt from standard corporate taxation by distributing over 90% of income to unit holders (the MLP terminology for shareholder). As such, these entities operate in stable revenue generating businesses to ensure stability of cash flow.
In the case of MLPs that sell oil and gas, they use hedges to reduce exposure to price volatility. Since none of us can predict the future of prices, a good conservative hedge book of prices can determine the strength of an MLPs future cash flows, and hence its payout.
Sifting through the MLP space, there are a few names that offer excellent yields while maintaining quality business operations. Of course since they all operate within the energy sector, any abrupt shocks in the industry will affect these partnerships, although one can expect less volatility due to price hedges.
MLPs like Boardwalk Pipeline Partners (NYSE:BWP) and Plains All American (NYSE:PAA) both engage in the transportation of oil and gas through owned pipelines and gathering systems. Both currently yield over 7%, nearly 5% over 10-year Treasury's and double the yield of many quality blue chips. The ownership of pipelines has been a very difficult business lately as declining energy prices make it more difficult for many to meet debt obligations. In normal environments, it is sensible to use debt to finance stable cash flow producing assets. But when business declines along with disappearing credit markets, things can get real tough real quick.
Boardwalk and Plains are no exceptions to the debt scenario, yet both seem in better shape than many. Boardwalk also happens to have conglomerate Loews (NYSE:L) as the controlling partner, a somewhat comforting notion. Penn West Energy Trust (NYSE:PWE), a Canadian company, currently yields 10.3%, a product of a monthly cash distribution.
Canadian energy trusts have been shaken up recently as investors digest the sector's prospects regarding tax changes set to take place in 2011. Certainly 2010 should be an interesting year for the stocks, as most of the trusts will likely convert to corporations ahead of a 2011 tax law change. Penn West along with Pengrowth (NYSE:PGH), another Canadian energy trust yielding about 9%, have already outlined plans for conversion due to the new legislation. (For related reading, check out Drilling For Big Tax Breaks.)
The Bottom Line
Yields, despite how high and attractive they may seem, are not a sole reason to invest in any company. However, the relative premium one gets from energy MLPs are very attractive when one couples them with the best in the lot. (For more, see Income Funds 101.)
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