Archive for the ‘MLP Investing’ Category
Monday, December 15th, 2008 |
Ken Fisher is one of my favorite columnists and a well respected writer for Forbes magazine. His personal investing mantra, while deceptively simple, goes something like “the key to being a successful investor is to know something that others don’t know”. Well, ok - that seems pretty basic, right? We’d all like to know what others don’t know.
Personally, I think it is more about taking the time to learn what others won’t or choose not to learn. Take the Master Limited Partnership for example - one of probably the least understood, yet most tax efficient investment vehicles available to the public. The wealthy typically benefit from these investments because they have the luxury of private-client wealth managers and estate planning (i.e., they are fortunate enough to “know what others don’t know”). However, the average Joe (like you and me) can also benefit in the same way.
MLPs and Estate Planning
So, why do the rich just keep getting richer? Money that rolls from generation to generation, besides benefiting from the power of compounding interest, also grows through good estate planning. That means making sure the estate is structured in the most tax efficient manner possible. MLPs are excellent vehicles for this - why? Per Investopedia’s article titled Discover Master Limited Partnerships:
“MLPs can be used to gain current income while deferring taxes…This can be taken one step further when an MLP investment is used as a vehicle for estate planning. When an MLP unitholder dies and the investment is transferred to an heir, the cost basis is reset to the market price on the transfer date, eliminating any accrued tax liability caused by return of capital.”
How’s that for tax efficient? When you die and pass on any LP units to your heirs, you effectively shield them from taxes by resetting their accrued liability to zero. Not too shabby, eh?
Posted in MLP Investing | No Comments »
Saturday, September 27th, 2008 |
Barron’s published an interesting interview with Jay Rosenberg, manager of the First American Global Infrastructure fund. According to Rosenberg, pipelines and infrastructure related companies are attractive in the current economic environment because they offer stable cash flows. Specifically, Rosenberg says:
…we are generally much more focused on those companies that transport petroleum — both crude refined products — and natural gas. But they do so in a way that is very contractual in nature and where their earnings don’t fluctuate very much based on the volumes that they are shipping. The company that best typifies what I’m talking about would be Enbridge (ENB), in particular because of the contractual nature of its gas load. Another company that we like in is Kinder Morgan …whose institutional shares (KMR) we own. Kinder Morgan has a fantastic portfolio of pipeline assets but also has some of the best unique storage assets in the US…
Related Links:
Barron’s Article (subscription may be required)
Posted in Energy, MLP Investing, Midstream MLPs | No Comments »
Tuesday, September 23rd, 2008 |
The Master Limited Partnership is a tax efficient, cash generating machine. In the MLP model, the majority of cash generated in a given period is passed directly through to investors. However, some cash is retained in order to fund future projects or growth. Understanding the difference between how much was paid out to investors and how much could have been paid out is key.
Distributable Cash Flow (DCF)
Stock investors typically use a metric called “Free Cash Flow” as a gauge of a company’s ability to generate cash (after adjusting for expenses relating to maintaining its assets). This cash can then be used to fund additional projects or pay out dividends. Similarly, MLP investors use Distributable Cash Flow (DCF) as a measure of cash available to distribute to unitholders or fund growth.
Calculating DCF is fairly simple, and involves working backward from Net Income on the Income Statement and adding back accounting related items. Remember that accounting items like depreciation and amortization are typically subtracted from income to represent the loss of value of different assets over time. However, they don’t really have anything to do with generating cash, so we want to make sure we add them back to net income. The calculation is:
The Coverage Ratio
So, now we know how to calculate Distributable Cash Flow (which represents what we could pay to investors if we wanted to). However, it’s always a smart idea to retain some of the cash generated to fund future growth or as an emergency fund. Thus, the amount actually paid out (the actual distributed amount) will typically be less than DCF. As a general rule, we like to see the ratio of DCF to the actual distribution to be greater or equal to 1.3. This ratio is referred to as the “coverage” ratio and is calculated as:
Coverage Ratio = Distributable Cash Flow / Actual Distributed Cash Flow
In our example above, if we have $225 million in DCF, we would likely actually distribute around $173 million to investors to maintain a coverage ratio of 1.3x.
Posted in MLP Investing, MLP Metrics, MLPs | 1 Comment »
Saturday, September 20th, 2008 |
One of the largest MLPs in existence today is Houston based Enterprise Products Partners. As measured by enterprise value, EPP is second only to MLP bellwether Kinder Morgan at $21 billion. However, from a liquidity standpoint (the ability to trade LP units on the open market - a key concern of many investors) it bests Kinder Morgan with an average of 560K units traded daily.
Overview
Like many of its peers, EPP is focused on providing midstream energy services to natural gas, natural gas liquids (NGL) and crude oil producers and consumers. Its primary method of doing so is its extensive network of pipelines (both offshore & onshore) which span over 35K miles in length. However, a key differentiator is its ability to tie import / export of NGLs with domestic and international consumers. In fact, NGL has become a very profitable business for EPP, with over half the partnership’s gross operating margin derived from NGL pipelines and services.
The Numbers
Investors like consistency, fiscal conservatism, and cash - and EPP seems to fit the bill with all 3. The partnership has grown cash distributions to LP unitholders at an annual growth rate of 9% per year since 1999, and grew total assets at a 39% CAGR during the same period.
Jan - June 2008 operating margins grew at a double digit pace vs. 2007 with strong performance across all pipeline business segments. Further, distributable cash flow (DCF) grew 41% in 1H ‘08 vs. 1H ‘07 to $730 MM, and the amount of retained DCF grew over 4X to $212 MM. This gives the partnership a comfortable coverage ratio of around 1.47.
In Sum
I don’t issue buy or sell recommendations for any type of security. However, I like EPP and will continue to watch this company as it pursues more projects and grows in the midstream energy space.
Posted in MLP Investing, Midstream MLPs | No Comments »
Friday, August 8th, 2008 |
The Master Limited Partnership (MLP) has two key components. At the core of the MLP is the General Partner (GP), which actually runs daily operations (e.g., physical management of a pipeline, billing, accounting, etc.) Limited Partners (LPs), on the other hand, are passive investors in the business and have no part in daily operations. The goal of the GP is to grow cash distributions (similar to a stock dividend) to the LPs and, since most MLPs operate in the energy space, these distributions tend to grow steadily over time. (more…)
Posted in MLP Investing, MLPs, Midstream MLPs | No Comments »
Wednesday, August 6th, 2008 |
Standard & Poors has a pretty good article on its website outlining the basics of MLPs. Of particular interest is the low correlation of MLP returns with those of stocks and bonds. For those not familiar with asset allocation theory, combining investment classes that have low correlations with each other is a good way to remain diversified. Further, it can allow you to boost returns while actually lowering portfolio risk.
Related Links:
Standard & Poors MLP Primer
Posted in MLP Investing, MLPs | No Comments »
Monday, August 4th, 2008 |
MLPs have several advantages that make them appealing investments. One key advantage is the absence of double taxation when it comes to paying dividends to investors. Common stockholders, for example, are essentially taxed twice on company earnings: once at the corporate level (the company itself has to pay taxes to the US government on earnings) and again when they receive dividend payments.
MLP unitholders, however, only pay taxes when they receive a dividend payment (called a “distribution”). Further, MLPs can defer paying taxes on the majority of the distribution until the units are actually sold. Not bad, eh?
Always Know the Downside
Don’t forget to do your research. In some cases, MLP unitholders may have to pay taxes in each state where the partnership operates. I strongly encourage everyone to consult a tax advisor before attempting to invest in these vehicles. They can be great investments only if you do the research and follow the rules.
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Saturday, August 2nd, 2008 |
It’s been a rough year for the markets, as major equity indexes suffered significant losses in the wake of subprime lending, rising inflation, and slowing economic growth. So it’s no surprise that publicly traded MLPs have also had their share of bad luck lately. However, as with any investment, there is risk involved. SemGroup Energy Partners is a good example of why investors should always understand the potential downside involved when investing in MLPs. (more…)
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Thursday, February 7th, 2008 |
MLPs and the Market
The media focus on a US recession and a declining stock market continues to escalate. However, one thing is clear: demand for midstream services and MLPs is here to stay. The logic is easy to follow. Regardless of commodity prices, oil and natural gas will always need to get shipped from one place to another via pipelines. Further, other midstream services such as fractionation and storage are essential to making this entire process work.
Sleeping Giants
The master limited partnership (MLP) is the most efficient corporate tax structure for midstream assets. Not only does it eliminate the pitfalls of double taxation of dividends, but it often allows for a built in hedge against inflation. As large institutional investors start to understand how MLPs work, they will realize that the benefits far outweigh any of the potential risks.
The Value Proposition
Currently, because institutional investment remains low, the price variability of LP units is higher than most US large cap stocks. However, for the long term investor who is comfortable with near term risk and is willing to do more work at tax time, the value proposition remains clear: Per the Alerian MLP Index, MLPs have returned an average of 19% annually over the last 5 years, and 16% over the last 10 years.
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Sunday, January 27th, 2008 |
Despite the recent volatility in the markets and media focus on a possible US recession, investors should remain focused on the long term potential of MLPs. There is a good chance that the major market indices will continue to fluctuate and lose value (including the benchmark Alerian MLP Index). Even so, midstream transport and services will continue to be in demand regardless of commodity prices and market conditions. Further, the fact remains that MLP distribution yields remain competitive and continue to grow. Over the long term, MLPs as measured by the Alerian index have outperformed the S&P and the Dow, and I believe they will continue to do so for the foreseeable future.
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