A Primer on Master Limited Partnerships

I first heard of Master Limited Partnerships or MLP’s a few years ago while watching a CNBC segment where a few fund managers talked about the little known space and MLP’s benefits. The space was so obscure to the investment public that these fund managers were barely in their upper 20’s.

Fast forward a few years and not much has changed in either MLP’s benefits or their level of awareness to the public. MLP’s are also referred to as publicly traded partnerships. The major benefit of MLP’s comes from taxation since income generated by the MLP is tax free. Since MLP’s have no corporate income tax, MLP’s typically pay very high quarterly dividends. A person who purchases shares in an MLP becomes a unit holder or one of the partners. MLP’s are mainly available in commodities, energy and real estate.

Here is another article, Master Limited Partnerships: A New Way to Shop for Bargains, that discusses some more recent opportunities in MLP’s.

Taken from the article:

Most investors have never heard of, or purchased, shares of a master limited partnership (MLP). But, with many yielding more than 10% and prices at historically low levels, these bargains are getting hard to ignore.

Few investors know that master limited partnerships are publicly traded asset pools. They have the tax benefits of a partnership plus the liquidity of a publicly traded stock.

Because they invest in many different types of assets, most master limited partnerships have significant debts on the balance sheet and have suffered from the credit crisis. But not all debt is bad debt. And their crisis could be your opportunity.

Profit From Master Limited Partnerships In the Energy Sector

I prefer master limited partnerships in the energy sector because their business is easy to understand. The ones that interest me own the pipes that move oil and natural gas from production to marketplace. Some of these companies also process natural gas, and they may even own an oil or gas field directly.

These companies are like utilities for energy production. Without their infrastructure, oil and gas couldn’t move to the consumers who need it. They play an integral part in the supply chain, and this makes their income stream steady and predictable.

The market has unfairly beaten up the prices of these partnerships. And the bankruptcy at Lehman Brothers only made things worse. They were dumping assets even before they went under. As a lender and advisor in this sector, Lehman was a major player in master limited partnerships.

One of my favorite master limited partnerships is Boardwalk Pipeline Partners (NYSE: BWP) - a firm that handles the storage and transportation of natural gas. Its largest shareholder, Loews Corp. (NYSE: L) heavily influenced BWP by assembling the core company assets, and taking the partnership public. It still owns 52% of the shares.

Loews Corp is controlled by the prominent Tisch family - known for their financial discipline. Boardwalk is no exception. It generates consistent cash flows and has limited debt. It has a ratio of long-term debt to capital of only 38%. Yet at a current share price of $16.30, it yields 11.5%.

Boardwalk’s shares have fallen 48% over the past 12 months. But even if energy prices stay depressed, it should rebound when the market sell-off subsides.

The Master Limited Partnership of NYSE: KMP

Another master limited partnership that I like is Kinder Morgan Energy Partners (NYSE: KMP). KMP is the largest independent owner and operator of petroleum-products pipeline in the United States, transporting more than two million barrels a day of gasoline, jet fuel, diesel fuel and natural gas liquids through over 8,300 miles of pipelines.

It is a major transporter of natural gas in Texas, the Rocky Mountains and the Midwest. The natural gas pipelines business segment consists of approximately 14,700 miles of pipelines with transportation capacity of about seven billion cubic feet per day, and working gas storage capacity of about 35 billion cubic feet. They also own or operate additional natural gas gathering, treating and processing facilities.

CEO David Kinder said in the dividend announcement, “While no company is 100% immune to external conditions, KMP continues to demonstrate that our diversified portfolio of stable assets is capable of generating consistently strong cash flow, even in extremely difficult market conditions.”

Having been formed in 1992, Kinder Morgan has now raised dividends for 12 years in a row - an exceptional record for a company that young. In fact, this pipeline giant just announced it was raising its payout again - increasing cash distributions per partnership unit from 99 cents to $1.02. With today’s price of $48.45, this puts its yield at 8.4%.

Master Limited Partnership Investing With An ETF

Another option for master limited partnerships is an exchange traded fund (ETF) that specializes in investing in the energy sector. The master limited partnership & Strategic Equity Fund (NYSE: MTP) holds a basket of energy master limited partnerships, and it’s currently yielding nearly 14%.

Many of these partnerships look incredibly inexpensive and they’re generating steady income. The income they offer will pay you until the share prices recover - perfect for investors looking for an alternative to stocks in this volatile market.

Owning these makes you a limited partner, which allows you to claim a share of the master limited partnership’s depreciation on your tax returns. In addition, they avoid the corporate income tax, on both state and federal levels. You still would owe tax payments ­(just like your other investments), but you suffer no double taxation.

This is why master limited partnerships are not appropriate for tax-deferred accounts - such as an IRA - because you would lose the ability to deduct this depreciation.

If crude oil and gas prices fail to stabilize, then sentiment against these master limited partnerships could stay negative. And that could mean even better bargain shopping down the road…