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How to Find the Best Master Limited Partnerships (MLPs)

by Harry Domash

About MLPs MLP Tax & Liability Considerations MLP Directory

In a soft economy, your best stock bets are steady-eddies with minimal downside risk, and paying higher dividends than you get from CDs.

Energy pipeline operators might fill that bill. They transport crude oil, natural gas, and other petroleum products through their pipelines. They enjoy a stable and profitable business, because, in most cases, their fees are based on the volume of product transported, not on the price of oil or natural gas. Pipelines rarely duplicate one another’s routes, so they have no competition.

Because the demand for petroleum products is rising, many pipeline operators are growing earnings and dividends, either by acquiring existing pipelines from third parties, building new pipelines, or by increasing the capacity of existing facilities.

Master Limited Partnerships (MLPs)
The pipeline operators that pay high dividends are usually organized as Master Limited Partnerships (MLPs). Although not corporations, MLPs trade on major stock exchanges, just like stocks.

MLPs have a general partner and limited partners. The general partner manages the operation and individual investors are limited partners. The general partner receives a percentage of the profits off the top, before the limited partners get their cut.

MLPs have their own lingo. Shares are called units and dividends are called distributions. So instead of paying dividends to shareholders, MLPs pay distributions to unit holders.  

Currently, most MLPs are paying distributions equating to 5% to 9% distribution yields (your yield is the next 12 months expected distributions divided by the price you paid for the units).

MLPs pay those big distributions because they don’t pay corporate income taxes. Instead, the income is allocated to the partners.  

Tax Issues
Master Limited Partnerships offer potential tax advantages because most of their distributions are classified as a return of investment instead of income. You don’t pay taxes on that portion until you sell. However, when you do sell, you’ll be taxed at the ordinary income rate, not as capital gains.

On the downside, MLPs require the use of special forms at tax time, which some investors consider too complicated. Also, holding MLPs in tax-sheltered accounts such as IRAs could incur penalties if you collect distributions totaling more than $1,000 annually. If that’s your situation, consult a tax advisor before investing.

Finding MLPs
Screening is the best way to find worthwhile MLP candidates. If you’re not familiar with the term, stock screeners are programs available on financial sites that you can use to search the entire market for stocks meeting your particular requirements.

Yahoo’s Basic Stock Screener is the only free screener I know of that can search specifically for pipeline operators.

From the Yahoo Finance homepage (finance.yahoo.com), select Investing, click on stocks, and then select “Launch HTML Screener.”

Set Up Your Screen
Once there, click on “Oil & Gas Pipelines” in the Industry Selection box to confine your search to stocks in that category. Next, specify your minimum acceptable dividend yield. I set my minimum at 5% because that is well above current CD rates. Try lowering it to 4% if you want to see more stocks.

Your best prospects are MLPs that are growing earnings, and hence distributions. Stock analysts generally forecast the next five year’s average annual earnings growth rate for stocks that they cover. Yahoo lets you screen on consensus (average) five-year earnings growth forecasts. I selected 5% minimum, which is good for high dividend stocks.

Analysts usually publish buy, sell, or hold ratings on stocks that they cover. Those ratings are based mostly on earnings growth expectations, not dividend safety or expected dividend growth, which would be of more value to us. Thus, I reasoned that as long as analysts aren’t advising selling a stock, it’s a viable candidate. I required “Hold Rating or better” for average analyst recommendation.

Found Six MLPs
Yahoo listed six MLPs with yields ranging from 5.8% to 9.0% when I ran the screen: Copano Energy (5.8% yield), Enbridge Energy Partners (7.4%), Energy Transfer Partners (9.0%), Magellan Midstream Partners (5.9%), Oneok Partners (6.4%) and Sunoco Logistics Partners (6.6%).

Copano is not an MLP, it’s a “Limited Liability Company” or LLC. As such, Copano has no master partner to take a cut off the top. All of the profits go to shareholders. However, for tax purposes, LLCs are treated the same as MLPs.

As the case for all screens, consider the results as candidates for further research, not a buy list.

You can’t analyze an MLP the same as you would a regular stock. MLPs own lots of assets that result in large depreciation charges that subtract from reported earnings, but don’t affect the cash flow that fuels distributions. Your best prospects are MLPs with a strong distribution growth history and plenty of pipeline construction projects underway.

You can see the distribution growth history on Yahoo by getting a price quote, clicking on Historical Prices and then selecting “Dividends Only.” 

You can learn about an MLP’s expansion plans by reading the management summary portions of their quarterly and annual reports. You can see the SEC reports on Yahoo by selecting SEC Filings and then looking for reports labeled 10-Q (quarterly) and 10-K (annual). Once you’ve found a report, select Summary to read the management’s discussion.

This may sound like work, but if you pick the right MLPs, you’ll probably end up holding them for years, so it’s time well spent. 

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