Updated on October 16th, 2020 by Bob Ciura
Spreadsheet data updated daily
Master limited partnerships – or MLPs, for short – are some of the most misunderstood investment vehicles in the public markets. And that’s a shame, because the typical MLP offers:
- Tax-advantaged income
- High yields well in excess of market averages
- The bulk of corporate cash flows returned to shareholders through distributions
An example of a ‘normal’ MLP is an organization involved in the midstream energy industry. Midstream energy companies are in the business of transporting oil, primarily though pipelines. Pipeline companies make up the vast majority of MLPs.
Since MLPs widely offer high yields, they are naturally appealing for income investors. With this in mind, we created a full downloadable list of all MLPs in our coverage universe.
You can download the Excel spreadsheet (along with relevant financial metrics like dividend yield and payout ratios) by clicking on the link below:
This comprehensive article covers MLPs in depth, including the history of MLPs, unique tax consequences and risk factors of MLPs, as well as our 8 top-ranked MLPs today.
The table of contents below allows for easy navigation of the article:
Table of Contents
- The History of Master Limited Partnerships
- MLP Tax Consequences
- Advantages & Disadvantages of Investing in MLPs
- The 8 Best MLPs Today
#8: Sunoco LP (SUN)
#7: MPLX LP (MPLX)
#6: Brookfield Renewable Partners (BEP)
#5: NextEra Energy Partners (NEP)
#4: Brookfield Infrastructure Partners (BIP)
#3: Magellan Midstream Partners (MMP)
#2: Enterprise Products Partners (EPD)
#1: Energy Transfer LP (ET)
- MLP ETFs, ETNs, & Mutual Funds
- Final Thoughts
The History of Master Limited Partnerships
MLPs were created in 1981 to allow certain business partnerships to issue publicly traded ownership interests. The first MLP was Apache Oil Company, which was quickly followed by other energy MLPs, and then real estate MLPs.
The MLP space expanded rapidly until a great many companies from diverse industries operated as MLPs – including the Boston Celtics basketball team.
Below, you can see a diagram showing the change in the sector concentration of MLPs over time.
Source: Energy Infrastructure Council ‘MLP 101’ Presentation, slide 20
One important trend that can be seen in the diagram above is that energy MLPs have grown from being roughly one-third of the total MLP universe to containing the vast majority of these securities.
Moreover, the energy MLP universe has evolved to be focused on midstream energy operations. Midstream partnerships have grown to be roughly half of the total number of energy MLPs.
Source: Energy Infrastructure Council ‘MLP 101’ Presentation, slide 21
MLP Tax Consequences
Master limited partnerships are tax-advantaged investment vehicles. They are taxed differently than corporations. MLPs are pass-through entities. They are not taxed at the entity level. Instead, all money distributed from the MLP to unit holders is taxed at the individual level.
Distributions are ‘passed through’ because MLP investors are actually limited partners in the MLP, not shareholders. Because of this, MLP investors are called unit holders, not shareholders. And, the money MLPs pay out to unit holders is called a distribution (not a dividend).
The money passed through from the MLP to unit holders is classified as either:
- Return of Capital
- Ordinary Income
MLPs tend to have lots of depreciation and other non-cash charges. This means they often have income that is far lower than the amount of cash they can actually distribute. The cash distributed less the MLPs income is a return of capital.
A return of capital is not technically income, from an accounting and tax perspective. Instead, it is considered as the MLP actually returning a portion of its assets to unit holders.
Now here’s the interesting part… Returns of capital reduce your cost basis. That means taxes for returns of capital are only due when you sell your MLP units. Returns of capital are tax-deferred.
Note: Return of capital taxes are also due in the event that your cost basis is less than $0. This only happens for very long-term holding, typically around 10 years or more.
Each individual MLP is different, but on average an MLPs distribution is usually around 80% to 90% a return of capital, and 10% to 20% ordinary income.
This works out very well from a tax perspective. The images below compare what happens when a corporation and an MLP each have the same amount of cash to send to investors.
Note 1: Taxes are never simple. Some reasonable assumptions had to be made to simplify the table above. These are listed below:
- Corporate federal income tax rate of 21%
- Corporate state income tax rate of 5%
- Qualified dividend tax rate of 20%
- Distributable cash is 80% a return of capital, 20% ordinary income
- Personal federal tax rate of 22% less 20% for passive entity tax break
(19.6% total instead of 22%)
- Personal state tax rate of 5% less 20% for passive entity tax break
(4% total instead of 5%)
- Long-term capital gains tax rate of 20% less 20% for passive entity tax break
(16% total instead of 20%)
Note 2: The 20% passive income entity tax break is part of President Trump’s new tax plan, and will expire in 2025.
Note 3: In the MLP example, if the maximum personal tax rate of 37% is used, the distribution after all taxes is $8.05.
Note 4: In the MLP example, the accrued cost basis reduction tax is due when the MLP is sold, not annually come tax time.
As the tables above show, MLPs are far more efficient vehicles for returning cash to shareholders relative to corporations. Additionally, in the example above $9.57 out of $10.00 distribution would be kept by the MLP investor until they sold because the bulk of taxes are from returns of capital and not due until the MLP is sold.
Return of capital and other issues discussed above do not matter when MLPs are held in a retirement account.
There is a different issue with holding MLPs in a retirement account, however. This includes 401(k), IRA, and Roth IRA accounts, among others.
When retirement plans conduct or invest in a business activity, they must file separate tax forms to report Unrelated Business Income (UBI) and may owe Unrelated Business Taxable Income (UBTI). UBTI tax brackets go up to 37% (the top personal rate).
MLPs issue K-1 forms for tax reporting. K-1s report business income, expense, and loss to owners. Therefore, MLPs held in retirement accounts may still qualify for taxes.
If UBI for all holdings in your retirement account is over $1,000, you must have your retirement account provider (typically, your brokerage) file Form 990-T. You will want to file form 990-T as well if you have a UBI loss to get a loss carryforward for subsequent tax years. Failure to file form 990-T and pay UBIT can lead to severe penalties. Fortunately, UBIs are often negative. It is a fairly rare occurrence to owe taxes on UBI.
The subject of MLP taxation can be complicated and confusing. Hiring a tax professional to aid in preparing taxes is a viable option for dealing with the complexity.
The bottom line is this: MLPs are tax-advantaged vehicles that are suited for investors looking for current income. It is fine to hold them in either taxable or non-taxable (retirement) accounts. Since retirement accounts are already tax-deferred, holding MLPs in taxable accounts allows you to ‘get credit’ for the full effects of their unique structure.
4 Advantages & 6 Disadvantages of Investing in MLPs
MLPs are a unique asset class. As a result, there are several advantages and disadvantages to investing in MLPs. Many of these advantages and disadvantages are unique specifically to MLPs.
Advantages of MLPs
Advantage #1: Lower taxes
MLPs are tax-advantaged securities, as discussed in the “Tax Consequences” section above. Depending on your individual tax bracket, MLPs are able to generate around 40% more after-tax income for every pre-tax dollar they decide to distribute, versus Corporations.
Advantage #2: Tax-deferred income through returns of capital
In addition to lower taxes in general, 80% to 90% of the typical MLPs distributions are classified as returns of capital. Taxes are not 0wed (unless cost basis falls below 0) on return of capital distributions until the MLP is sold. This creates the favorable situation of tax-deferred income.
Tax-deferred income is especially beneficial for retirees as return on capital taxes may not need to be paid throughout retirement.
Advantage #3: Diversification from other asset classes
Investing in MLPs provides significant diversification in a balanced portfolio. Diversification can be measured by the correlation in return series between asset classes.
MLPs are excellent diversifiers, having either a near zero or negative correlation to corporate bonds, government bonds, and gold.
Additionally, they have a correlation coefficient of less than 0.5 to both REITs and the S&P 500. This makes MLPs an excellent addition to a diversified portfolio.
Advantage #4: Typically very high yields
MLPs tend to have yields far in excess of the broader market. As of this writing, the S&P 500 yields ~2.1%, while the Alerian MLP ETF (AMLP) yields over 25%. Many individual MLPs have yields above 10%.
Disadvantages of MLPs
Disadvantage #1: Complicated tax situation
MLPs can create a headache come tax season. MLPs issue K-1’s and are generally more time-consuming and complicated to correctly calculate taxes than ‘normal’ stocks.
Disadvantage #2: Potential additional paperwork if held in a retirement account
In addition, MLPs create extra paperwork and complications when invested through a retirement account because they potentially create unrelated business income (UBI). See the “Tax Consequences” section above for more on this.
Disadvantage #3: Little diversification within the MLP asset class
While MLPs provide significant diversification versus other asset classes, there is little diversification within the MLP structure. The vast majority of publicly traded MLPs are oil and gas pipeline businesses. There are some exceptions, but in general MLP investors are investing in energy pipelines and not much else. Because of this, it would be unwise to allocate all or a majority of one’s portfolio to this asset class.
Disadvantage #4: Incentive Distribution Rights (IDRs)
MLP investors are limited partners in the partnership. The MLP form also has a general partner. The general partner is usually the management and ownership group that controls the MLP, even if they own a very small percentage of the actual MLP.
Incentive Distribution Rights, or IDRs, are used to ‘incentivize’ the general partner to grow the MLP. IDRs typically allocate greater percentages of cash flows to go to the general partner (and not to the limited partners) as the MLP grows its cash flows. This reduces the MLPs ability to grow its distributions, putting a handicap on distribution increases.
It should be noted that not all MLPs have IDRs, but the majority do.
Disadvantage #5: Elevated risk of distribution cuts due to high payout ratios
One of the big advantages of investing in MLPs is their high yields. Unfortunately, high yields very often come with high payout ratios.
Most MLPs distribute nearly all of the cash flows they make to unit holders. In general, this is a positive. However, it creates very little room for error. The pipeline business is generally stable, but if cash flows decline unexpectedly, there is almost no margin of safety at many MLPs. Even a short-term disturbance in business results can necessitate a reduction in the distribution.
Disadvantage #6: Growth Through Debt & Share Issuances
Since MLPs typically distribute virtually all of their cash flows as distributions, there is very little money left over to actually grow the partnership.
And most MLPs strive to grow both the partnership, and distributions, over time. To do this, the MLP’s management must tap capital markets by either issuing new units or taking on additional debt.
When new units are issued, existing unit holders are diluted; their percentage of ownership in the MLP is reduced. When new debt is issued, more cash flows must be used to cover interest payments instead of going into the pockets of limited partners through distributions.
The 8 Best MLPs Today
- Return from change in valuation multiple
- Return from distribution yield
- Return from growth on a per-unit basis
The top MLPs list was screened further on a qualitative assessment of a company’s dividend risk. Specifically, MLPs with a Dividend Risk score of ‘F’ according to the Sure Analysis Research Database were omitted from the list.
Continue reading for detailed analysis on each of our top MLPs, ranked according to expected 5-year annual returns, but also ranked further by debt levels and strength of assets.
MLP #8: Sunoco LP (SUN)
Sunoco is a Master Limited Partnership that distributes fuel products through its wholesale and retail business units. The wholesale unit purchases fuel products from refiners and sells those products to both its own and independently-owned dealers. The retail unit operates stores where fuel products as well as other products such as convenience products and food are sold to customers.
Sunoco was founded in 2012, is headquartered in Dallas, and currently trades with a market capitalization of $2.1 billion.
Source: Investor Presentation
In the 2020 second quarter, Sunoco generated adjusted EBITDA of $182 million, an increase of 20% compared with $152 million in the second quarter of 2019. Adjusted distributable cash flow increased 21% for the quarter. Sunoco management attributed this growth to higher reported fuel margins and lower operating expenses as a result of cost-cutting.
Sunoco does not have a long history, as the company was created just a few years ago. During that time frame its results varied significantly. Going forward, Sunoco can generate growth through multiple factors. Following the sale of a large amount of its convenience stores, Sunoco is now more dependent on its fuel wholesale business, where it profits from significant scale and revenue consistency.
In Texas, Sunoco is one of the largest independent fuel distributors, and Sunoco is also among the top distributors of Chevron, Exxon, and Valero-branded motor fuel in the rest of the United States. In the fuel wholesale industry, scale is important, as increased scale allows for higher margins and a better negotiating position with both suppliers and customers. Total gasoline sales declined relatively steadily since the beginning of the current millennium, but bottomed in 2015 and started to rise again over the last three years.
This macro shift towards higher gasoline consumption, can be explained by customers’ preference for larger, less efficient models such as SUVs and trucks. Higher gasoline demand is a macro tailwind for Sunoco’s business. Investors should carefully weigh the various unique risk factors associated with investing in MLPs, as well as the company’s fairly high level of debt. SUN’s net debt to Adjusted EBITDA ratio was 4.07x at the end of the second quarter, down from 4.39x at the end of the first quarter.
Sunoco has an extremely high yield above 13%, but investors should always be wary of yields this high. The market is sending clear doubts as to the sustainability of the distribution. Indeed, Sunoco’s high debt level amidst a looming economic slowdown is very troublesome. The company had a distribution coverage ratio of 1.41x for the second quarter.
On a positive note, the company has taken action to shore up its financial position in recent weeks. The company recently announced it will reduce 2020 growth capital spending by 42% in response to the coronavirus. It will also cut full-year maintenance capex by approximately 33%, and intends to cut operating costs as well. Separately, Sunoco has a $1.5 billion revolving credit facility that matures in July 2023 and has no debt maturities prior to 2023.
Sunoco has been so beaten down that any corresponding snap-back could generate outstanding returns over the next five years. Valuation expansion and distributions alone could generate an extremely high rate of return. Of course, there is an elevated risk as well, meaning only investors with a high tolerance for risk should consider buying Sunoco.
MLP #7: MPLX LP (MPLX)
MPLX, LP is a master limited partnership that was formed by the Marathon Petroleum Corporation (MPC) in 2012. The business operates in two segments: Logistics and Storage – which relates to crude oil and refined petroleum products – and Gathering and Processing – which relates to natural gas and natural gas liquids (NGLs). On July 30th, 2019 MPLX completed the acquisition of Andeavor Logistics LP.
For the 2020 second quarter, net income equaled $648 million compared to $482 million previously. Distributable cash flow (DCF) equaled $1.027 billion, a slight increase from $1.007 billion in Q2 2019. MPLX’s unit count increased substantially due to the Andeavor acquisition. The company ended the quarter with a consolidated debt to adjusted EBITDA ratio of 4.1x. Distribution coverage was down from 1.41x to 1.39x for the quarter.
Source: Investor Presentation
MPLX has positive growth prospects, due primarily to its projects currently under development. Pipelines tend to have a stronghold in terms of extracting economic rents, and natural gas is cleaner than coal. In the last decade, natural gas has overtaken coal as the leading source of electricity generation in the U.S. Building pipelines requires years of approvals and ongoing regulation. MPLX in particular has a strong position in the Marcellus / Utica region, with long-term contracts from Marathon.
MPLX is an attractive stock for yield and distribution growth. MPLX has so far maintained its quarterly distribution at a rate of $0.6875 per unit. With a forward yield of 16%, future returns could be extremely high, although a yield this high is often a precursor to a dividend cut.
Still, even a significant cut would leave a very high yield, and there is at least a chance that the distribution remains intact, particularly if the global economy snaps back to growth over the second half of 2020. But once again, only investors with a high risk tolerance should consider buying MPLX.
MLP #6: Brookfield Renewable Partners (BEP)
Brookfield Renewable Partners L.P. operates one of the world’s largest portfolios of publicly-traded renewable power assets. Its portfolio consists of about 19,000 megawatts of capacity in North America, South America, Europe, and Asia.
Brookfield Renewable Partners is one of four publicly-traded listed partnerships that are operated by Brookfield Asset Management (BAM). The others are Brookfield Property Partners (BPY), Brookfield Infrastructure Partners (BIP), and Brookfield Business Partners (BBU).
Source: Investor Presentation
BEP earns its place on the list because of its high-quality assets, and its exposure to a major growth category within the MLP industry–renewable energy. Brookfield Energy Partners trades with a market capitalization of US$14 billion and is cross-listed on the New York Stock Exchange and the Toronto Stock Exchange, where it trades under the tickers ‘BEP’ and ‘BEP.UN’, respectively. Despite operating as a Canadian company, Brookfield Energy Partners reports financial results in U.S. dollars. All figures in this article are denominated in U.S. dollars.
In the 2020 second quarter, the company’s share of actual generation fell 7.6% while its long-term average generation capability (which represents how much electricity would be generated if all of the company’s assets generated electricity at their long-term average levels) rose 1.6%. Normalized funds from operations and per-unit normalized FFO both grew by 11% year-over-year, thanks to the contribution from recent acquisitions and recently commissioned facilities.
We expect Brookfield Renewable Partners to continue growing funds from operations at a meaningful pace via its heavy investing in new projects. The company recently acquired a 50% stake in X-Elio, a leading global solar developer, while it invested a total of $2.0 billion (~12% of its market cap) in new growth projects in 2019.
Brookfield Renewable Partners’ objective is “to deliver long-term annualized total returns of 12%-15%, including annual distribution increases of 5%-9% from organic cash flow growth and project development.” While the total return portion is based on the market price of the security, the distribution and business growth are under the company’s control. Units have an attractive current yield of 3.8%. We believe Brookfield Renewable Partners investors can expect organic growth of around 6% over the intermediate term.
We expect Brookfield to report FFO-per-unit of $2.60 for 2020. The units trade for a P/DCF ratio of 21, which is above our fair value estimate of 14. BEP is not the most undervalued MLP on this list, as a contracting valuation multiple could reduce annual returns going forward. But the company makes up for this with steady FFO growth, attractive distribution increases each year, and a strong business model geared toward future growth.
MLP #5: NextEra Energy Partners (NEP)
NextEra Energy Partners was formed in 2014 as Delaware Limited Partnership by NextEra Energy to own, operate, and acquire contracted clean energy projects with stable, long-term cash flows. The company’s strategy is to capitalize on the energy industry’s favorable trends in North America of clean energy projects replacing uneconomical projects.
Source: Investor Presentation
NextEra Energy Partners operates a portfolio of over 5,300 megawatts of renewables, approximately 86% of which is derived from wind with the remaining ~14% from solar. NEP also operates 4.3 billion cubic feet of natural gas pipeline capacity, encompassing over 700 miles of pipeline.
NextEra Energy (NEE), which owns approximately 83% of NextEra Energy Partners, has an impressive history of generating steady growth. From 2003 through 2018, NextEra Energy grew adjusted earnings-per-share and dividends by 7.8% and 9.1% per year, respectively.
We believe this is a promising baseline for NextEra Energy Partners. In the 2020 second quarter, NextEra Energy Partners reported adjusted EBITDA of $349 million and cash available for distribution (CAFD) of $166 million. These represent year-over-year growth rates of 23% and 46%, respectively. Over the first half of the year, adjusted EBITDA is up 26% while CAFD is up 86%, a highly impressive performance for NextEra Energy Partners.
Unitholders have benefited from the company’s strong growth with rising distributions. Along with second-quarter results, the company raised its quarterly distribution to $0.5775 per unit. The distribution represents a 4.1% increase from the prior quarterly distribution, and a 15% increase from the same quarterly payout last year.
NEP’s impressive growth is the product of excellent execution on all three avenues for growth during 2019: (1) acquiring a ~600 MW renewable portfolio from Energy Resources, (2) closing on a 3rd party acquisition of Meade Pipeline Co, and (3) announcing the re-powering of 275 MW worth of wind projects. The partnership also purchased all of the outstanding Genesis OpCo and HoldCo debt, unlocking $100 million of run-rate CAFD.
Meade Pipeline owns a 39.2% interest in the Central Penn Line, a 185-mile intrastate natural gas pipeline which supplies natural gas from the Marcellus region to various parts of the Mid-Atlantic and Southeastern regions of the U.S. The pipeline has capacity for 1.7 billion cubic feet of natural gas per day.
NEP management believes the company has sufficient liquidity to get through the coronavirus crisis in decent shape. Its only near-term debt maturity is a $300 million convertible debt issuance that matures in September 2020–it has no other corporate level debt maturities until 2024.
We expect growth from further expansion in renewable energy sales and addition of new infrastructure to drive an average annual growth rate of 4% throughout the next half decade to 2025. Equally promising are the company’s future growth prospects, as it is at the forefront of the renewable energy revolution, particularly in the areas of wind and solar. It also has a solid yield of 3.5%, and a secure distribution, with an added bonus of growth potential.
MLP #4: Brookfield Infrastructure Partners (BIP)
Brookfield Infrastructure Partners is one of the largest global owners and operators of infrastructure networks, which includes operations in sectors such as energy, water, freight, passengers, and data. Brookfield Infrastructure Partners is one of four publicly-traded listed partnerships that is operated by Brookfield Asset Management (BAM). Brookfield Infrastructure Partners is a large-cap stock with a market capitalization of $20 billion.
Source: Investor Presentation
Brookfield Infrastructure has held up fairly well to start the year, given the heavy impact of the coronavirus crisis on the global economy. In the 2020 second quarter, funds-from-operations (FFO) fell just 1% to $333 million. FFO per unit fell 5% to $0.72on a split-adjusted basis. In the first half of the year, FFO was essentially flat against the 2019 first half, while FFO per unit fell 4% on a split-adjusted basis.
During the first half of 2020, of Brookfield Infrastructure’s four key segments, only the Transport segment saw a meaningful decline of 17% in FFO due to the sale of a European port business and an interest in its Chilean toll road operation. Declines were also due to government-imposed shut-downs.
The company has expanded its diversified portfolio of quality infrastructure assets in recent years. In December 2019, Brookfield Infrastructure Partners made two significant acquisitions to boost its growth pipeline. First, the company acquired a 100% stake in a telecom tower company in India from Reliance Industrial Investments and Holdings Limited, a wholly-owned subsidiary of Reliance Industries Limited, for $3.7 billion.
Of this, Brookfield Infrastructure invested approximately $375 million, with the balance funded by its institutional partners. The assets being acquired include approximately 130,000 communication towers.
Separately, last year BIP also acquired Cincinnati Bell for $2.6 billion, including debt. Cincinnati Bell owns and operates a data transmission and distribution network in Ohio and Hawaii, serving broadband, video, and voice services to over 1.3 million homes as well as enterprise customers.
Going forward, BIP will likely continue to deliver attractive FFOPS growth. We expect 8.0% annual FFO-per-unit growth, while the MLP also offers a 4.4% yield. As the payout ratio is estimated to be about ~60% this year, the cash distribution is very safe. What adds to BIP’s dividend safety is that its FFO is very stable.
Since 2012, FFOPS has remained stable or has steadily increased every year. The infrastructure that the company provides is needed during recessions as well, which is why FFO would likely remain relatively stable during a downturn or economic crisis. BIP also maintains a solid investment-grade credit rating of BBB+.
MLP #3: Magellan Midstream Partners (MMP)
Magellan Midstream Partners has the longest pipeline system of refined products in the U.S., which is linked to nearly half of the total U.S. refining capacity. Its network of assets includes 9,800 miles of pipeline, 54 storage terminals, and 46 million barrels of storage capacity.
Refined products generate approximately 59% of its total operating income while crude oil and marine storage represents the remaining 41%. Magellan has a market capitalization above $8 billion.
Source: Investor Presentation
In late July, the company reported (7/30/20) financial results for the second quarter of fiscal 2020. Distributable cash flow fell by one-third, from $314.8 million to $209.5 million, due to the reduced demand for refined products and the suppressed commodity prices caused by the pandemic. Magellan essentially kept its guidance intact for distributable cash flow of $1.0-$1.05 billion this year. The company intends to maintain its quarterly distribution constant for the rest of the year and expects a distribution coverage ratio of 1.10-1.14.
Magellan’s extensive and diversified network of pipeline and storage assets is a significant competitive advantage. Another competitive advantage is its fee-based model in which the company generates fees based on volumes transported and stored and not on the underlying commodity price. This helps insulate Magellan from sharp declines in commodity prices. Only ~10% of its operating income depends on commodity prices. But with that said, with such a glut of oil at the moment less oil is likely to be transported since there’s so much excess being stored.
Magellan has promising growth prospects in the years ahead, as it has several growth projects under way. During the last decade, the company invested $5.4 billion in growth projects and acquisitions and has exhibited much better performance than the vast majority of MLPs.
It also sold 3 marine terminals to Buckeye Partners (BPL) for $250 million. After the sale, the company intends to buy back up to $750 million of its own stock. This buyback could help boost future per-unit earnings and FFO growth.
Magellan has an excellent track record of steadily growing its distribution, and strong distribution safety. Magellan has increased its distribution 71 times since its initial public offering in 2001, including a recent 3% year-over-year increase. The company expects to maintain a distribution coverage ratio of at least 1.2x over the next several years, which will be sufficient to raise the payout each year. Magellan also has a strong debt profile, with a high credit rating of BBB+ from Standard & Poor’s.
The company also said it expects to maintain a leverage ratio of 3.4x to 3.7x by the end of the year. Therefore, Magellan earns a high ranking on this list for its combination of an 11% yield, but also its strong credit rating and long history of distribution increases.
MLP #2: Enterprise Products Partners (EPD)
Enterprise Products Partners was founded in 1968. It operates as an oil and gas storage and transportation company. Enterprise Products has a tremendous asset base which consists of nearly 50,000 miles of natural gas, natural gas liquids, crude oil, and refined products pipelines. It also has storage capacity of more than 250 million barrels.
These assets collect fees based on materials transported and stored.
Source: Investor Presentation
In the most recent quarter, Enterprise Products reported a relatively mild 6% decline in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) and an 8% decline in distributable cash flow. Lower volumes were responsible for the declines, especially in the company’s Natural Gas Pipelines & Services business which saw operating margin decline by 30%. However, operating margin held flat in the NGL Pipelines & Services segment, and increased 24% in the Crude Oil Pipelines & Services segment.
Enterprise Products expects 2020 growth capital expenditures in a range of $2.5 billion to $3 billion. The company plans to significantly curtail growth capital spending over the next two years to preserve cash flow. For 2021 and 2022, Enterprise Products expects to allocate $2.3 billion and $1.0 billion, respectively, for growth capital expenditures.
Despite the weak performance in the first quarter, we believe Enterprise Products still has positive long-term growth potential moving forward, thanks to new projects and exports. For example, Enterprise Products recently placed the 10th fractionator into service at Mont Belvieu, with an 11th expected to be placed into service in the third quarter.
Exports are also a key growth catalyst. Demand for liquefied petroleum gas and liquefied natural gas, or LPG and LNG respectively, is growing at a high rate across the world, particularly in Asia. In total, Enterprise Products has $4.7 billion of projects under construction expected to be placed into service in 2021 and beyond.
In terms of safety, Enterprise Products Partners is one of the strongest midstream MLPs. It has credit ratings of BBB+ from Standard & Poor’s and Baa1 from Moody’s, which are higher ratings than most MLPs. It also had a high distribution coverage ratio of 1.6x in the 2020 first half, meaning the company generated approximately 60% more distributable cash flow than it needed for distributions in the most recent quarter.
Another attractive aspect of Enterprise Products is that it is a recession-resistant company. Enterprise Products’ high-quality assets generate strong cash flow, even in recessions. As a result, Enterprise Products has been able to raise its distribution to unitholders for 21 consecutive years.
Like Magellan, Enterprise Products has a high credit rating of BBB+. In addition, it has world-class assets and a very long history of distribution increases. Combined with a 10.2% current yield, Enterprise Products is built to outlast a recession.
MLP #1: Energy Transfer (ET)
Energy Transfer is a midstream oil and gas Master Limited Partnership, or MLP. Energy Transfer’s business model is storage and transportation of oil and gas. Its assets have total gathering capacity of nearly 13 million Btu/day of gas, and a transportation capacity of 22 million Btu/day of natural gas and over 4 million barrels per day of oil.
Energy Transfer also owns Lake Charles LNG Company, as well as the general partner interests, the incentive distribution rights and 28.5 million common units of Sunoco LP, and the general partner interests and 46.1 million common units of USA Compression Partners LP (USAC).
Energy Transfer’s diversified and fee-based assets provide the company with steady cash flow, even when oil and gas prices decline. As a midstream operator, Energy Transfer’s cash flow relies heavily upon volumes, and less so on commodity prices.
Source: Investor Presentation
Energy Transfer reported second-quarter results in August. Adjusted EBITDA of $2.44 billion represented a decline of 14% year-over-year, a direct result of the coronavirus pandemic and related economic slowdown, which caused volumes and market prices to decline. Distributable cash flow of $1.27 billion fell by 21%. However, the company achieved a strong distribution coverage ratio of 1.54x for the quarter, which generated excess cash flow of $448 million beyond distributions for the quarter.
In response to the coronavirus, the company further reduced its growth capital expenditures by an additional $200 million. Energy Transfer expects growth capital expenditures to be approximately $1.3 billion in 2021 and $500 million to $700 million in 2022 and 2023.
The company is also making strong progress on several growth projects which should be adding to cash flows in the coming quarters and years.
Source: Investor Presentation
On September 1st, Energy Transfer announced the completion of the Lone Star Express Pipeline expansion project. The pipeline adds over 400,000 barrels per day of Natural Gas Liquids capacity.
The $5 billion acquisition of SemGroup Corp. will also fuel Energy Transfer’s growth. This will expand its natural gas liquids and crude oil capabilities with the addition of 18.2 million barrels of storage capacity. The gathering assets are in the DJ Basin in Colorado and the Anadarko Basin in Oklahoma and Kansas, as well as oil and NGL pipelines connecting the DJ and Anadarko basins with crude oil terminals in Oklahoma.
The company’s growth from new projects will help secure its attractive distribution, which currently yields over 20%. Energy Transfer has a very high yield, which makes it an attractive stock for income investors.
Energy Transfer trades for a price-to-cash flow ratio in the low single-digits, making it much cheaper than many other MLPs. In addition, it has an extremely high yield of 20%, which may signal a risk of a distribution cut as we have noted previously in this article. Therefore, income investors who cannot abide a distribution cut should look elsewhere.
We believe Energy Transfer is among the most undervalued MLPs. We also expect strong long-term growth (albeit with lots of short-term volatility), due to its asset strength, and recent acquisitions. The combination of all these factors makes it our top pick in the MLP space, but with an elevated level of risk.
MLP ETFs, ETNs, & Mutual Funds
There are 3 primary ways to invest in MLPs:
- By investing in units of individual publicly traded MLPs
- By investing in a MLP ETF or mutual fund
- By investing in a MLP ETN
Note: ETN stands for ‘exchange traded note’
The difference between investing directly in a company (normal stock investing) versus investing in a mutual fund or ETF is very clear. It is simply investing in one security versus a group of securities.
ETNs are different. Unlike mutual funds or ETFs, ETNs don’t actually own any underlying shares or units of real businesses. Instead, ETNs are financial instruments backed by the financial institution (typically a large bank) that issued them. They perfectly track the value of an index. The disadvantage to ETNs is that they expose investors to the possibility of a total loss if the backing institution were to go bankrupt.
The advantage to investing in a MLP ETN is that distribution income is tracked, but paid via a 1099. This eliminates the tax disadvantages of MLPs (no K-1s, UBTI, etc.). This unique feature may appeal to investors who don’t want to hassle with a more complicated tax situation. The J.P. Morgan Alerian MLP ETN makes a good choice in this case
Purchasing individual securities is preferable for many, as it allows investors to concentrate on their best ideas. But ETFs have their place as well, especially for investors looking for diversification benefits.
Master Limited Partnerships are a misunderstood asset class. They offer diversification, tax-advantaged and tax-deferred income, high yields, and have historically generated excellent total returns. You can download your free copy of all MLPs by clicking on the link below:
The asset class is likely under-appreciated because of its more complicated tax status, and because it is relatively new. The first MLP was created in 1981, so they are still a relatively new investment form.
MLPs are generally attractive for income investors, due to their high yields. As always, investors need to conduct their own due diligence regarding the unique tax effects and risk factors before purchasing MLPs. The recent and massive crash across the MLP space is due to plunging commodity prices and the potential for a prolonged recession from the coronavirus.
There is at least some likelihood that many MLPs will cut or suspend distributions, at least until the coronavirus-related panic subsides. That said, the MLPs on this list could be a good place to find long-term buying opportunities among the beaten-down MLPs.