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Upon seeing this title, you may be wondering to yourself, "What is an MLP (master limited partnership) and why should I care?"
Well if you know what it is, please move to the next section. If not, we're here to help briefly explain what they are and what makes them so unique!
The commonly accepted definition of an MLP is, "A business venture that exists in the form of a publicly traded limited partnership."
While that is extremely broad, these "partnerships" exist in the form of publicly traded companies that are often found in the energy sector.
But unlike most publicly traded energy stocks, MLPs combine the tax benefits of a private partnership with the liquidity of a publicly traded company.
And in order to take advantage of this special tax structure, MLPs are required to distribute 90% of their income to their investors.
So, the major takeaways from this is two things.
Because these companies have to pay 90% of their income to their investors, yields on their stock are usually north of 8% -- which is much higher than you'll find with most equities (more on this below).
And because of their tax status, investors are not taxed when receiving dividends.
The dividends, unlike with all other stocks, are tax-deferred until you sell your shares -- at which point it gets taxed at a lower & long-term capital gains rate.
Tax advantages of MLPs:
While many younger investors today are enamored with day trading, what most of them do not realize is that they get taxed at their normal income tax rate on these trades.
Therefore short-term trades become even riskier as these traders need to make significant gains to beat out the lower tax rates for longer-term investors!
Pair that with the tax advantages you get with MLPs and these immediately become a very attractive asset class for many investors looking for passive income with favorable tax treatments.
So now that we understand what MLPs 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 advantages discussed above, they have extremely high dividend yields. The dividend yield shows how much a company pays out in dividends 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%.
So, 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, before any potential in stock price appreciation!
For example, if we look at the MLP index, we see that it's increased roughly 25% in the last year. But when factoring in the effects of dividends we can see that the index has actually increased by ~32%. Comparing that to the S&P 500, we see that this index is actually down 11% (with dividends) over the last year.
Not only do they have extremely high yields but they also come with significant price appreciation potential. This is because while we've seen oil prices shoot up over the last year thanks to the teamwork of OPEC and rising inflation, they're unlikely to fall down significantly overnight.
While the MLP business model is unique from other energy stocks, given their fee-based model, they also participate in energy’s rally. So that's why when you factor in MLPs strong free cash flow, justified valuations, and a global macro recovery likely to occur next year -- there's a good chance we see another 12 months of outperformance with strong income.
Top 3 MLPs (in no order):
So now that you understand what MLPs are and why we like them, let's dive into our top 3.
Energy Transfer LP Unit (ET) 7.8% Dividend Yield: Energy Transfer is one of the largest and most diversified midstream energy companies in North America with approximately 120,000 miles of pipelines and associated energy infrastructure across 41 states. ~30% of America's natural gas and crude oil runs through their pipelines!
Similar with the stock below, ET and EPD both operate in the midstream segment -- however ET runs a riskier and more leveraged business as they're financed by a larger amount of debt than EPD. Because of this, they displayed more growth over the last year and thus their stock has outperformed EPD. However that's why ET is a higher risk/higher reward pick than EPD! If things ever take a turn, we'll want to watch how this debt affects their operations.
Enterprise Products Partners LP (EPD) 7.3% Dividend Yield: EPD is an American midstream natural gas and crude oil pipeline company with headquarters in Texas. The company ranked in the top 100 in the Fortune 500 list of the largest United States corporations by total revenue.
EPD is a monster, who is still looking to grow too -- just with less operational risk than ET. Increasing the yield and amount distributed every quarter since 2016, EPD is generating serious cash flow and distributing it to shareholders! This is another must-hold MLP but comes with less risk and less upside compared to ET. If you're looking for midstream exposure this is a great buy and hold stock.
Sunoco LP (SUN) 8.2% 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 still far from complete, global inflation and more driving being completed, SUN is in a great position to capture significant market share as they distribute their products across the world. Another MLP, although in a different sector than the two stocks above, SUN is a great way to get yield and capture upside across the energy sector. If you're looking for more exposure to the pumps, this is a great way to play the demand for gas.
Bonus: Alps Alerian MLP ETF (AMLP) 7.25% Dividend Yield: AMLP tracks the Alerian MLP Infrastructure Index. The 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 MLPs, this is a good way to get broad sector to the industry through an ETF! At the end of the day, many MLPs are situated in a similar environment, and just getting exposure and learning about what MLPs are, is half the battle.
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