Another Huge Dividend Play

I highlighted CVR Energy Partners (NYSE: UAN  ) for Fool.com readers a few months ago. Since then, the stock climbed as much as 69% before settling back during the recent market malaise. Still, it continues to be up a solid 17% (plus 10% more today) while the market is really hurting. The stock has held up so well because of its huge yield, which I peg at more than 9%, and I think it still has plenty of upside, too.

Today, I'm back to find another stock just like it. A fat dividend that drives the stock price higher is one of my favorite kinds of special situation. Get ready to meet the latest such candidate I've discovered.

I like big dividends and I cannot lie
The company is Eagle Rock Energy Partners LP (Nasdaq: EROC  ) , a U.S.-based partnership engaged in transporting natural gas and natural gas liquids (the midstream business) and developing and acquiring interests in oil and gas properties (the upstream business). The company's stated goal is to grow its business in order to increase cash distributions to its unitholders. (That's what owners of publicly traded partnerships are called.)

The midstream business is located in five significant natural-gas-producing areas around Texas, Louisiana, and the Gulf of Mexico. Its system here includes 5,482 miles of pipeline and 737 million cubic feet per day of processing capacity. The midstream segment provides Eagle Rock with relatively stable volumes, plus cash flows with the potential for growth.

The upstream business has long-lived properties in Alabama and Texas, including 273 operated wells and 137 non-operated wells, with about 5,000 barrels of oil equivalent a day, and proved reserves of 38.4 billion cubic feet of natural gas and 8.7 million barrels of crude oil. With commodities as volatile as they are -- particularly in the upstream business -- the company locks in higher prices when it can to escape the brunt of declining prices in the future, and stabilize its cash flows going forward.

As for its growth plans, the company tries to leverage its existing midstream infrastructure, but also looks for opportunities in brand-new projects outside its infrastructure. Eagle Rock is expanding its plant in the Granite Wash play -- one of the most active drilling sites in the U.S. -- from its current 50 million cubic feet per day capacity to 80 million, and it should be completed by the end of the year.

In the upstream business, the company relies on infill drilling -- tapping the spaces between existing well sites to eke out overlooked pockets of gas and oil -- and recompletion -- repairing and restoring wells to get them back in production -- to drive organic growth. It's also looking for smart acquisitions. In its most recent quarter, Eagle Rock acquired Tulsa-based natural gas producer Crow Creek Energy, helping to boost its natural gas segment's operating income by 102% in the second quarter. The company targets a rate of return of 18% and 20% on its midstream and upstream operations, respectively.

Eagle Rock's senior management team has an average of about 20 years of related experience, and those managers own significant stakes in the company.

And then there's that distribution...
Eagle Rock upped its distribution by 25% between its first and second quarters, to $0.1875, or $0.75 annualized. At Eagle Rock's current price, that implies a yield of 7.2%, a figure that sits comfortably above some of its peers in the publicly traded partnership space:

Company

TTM Yield

Distributions per share

Atlas Pipeline Partners LP (NYSE: APL  ) 5.4% $1.59
Linn Energy LP (Nasdaq: LINE  ) 7.2% $2.67
Inergy LP (NYSE: NRGY  ) 3.5% $0.98
El Paso Pipeline Partners LP (NYSE: EPB  ) 5.1% $1.79
Boardwalk Pipeline Partners LP 8.1% $2.08
Energy Transfer Partners LP (NYSE: ETP  ) 7.9% $3.58
Average 6.4%  

Source: Capital IQ, a division of Standard & Poor's.

These comps suggest that an average yield might be 6.4% in the partnership space, about in line with what I've shown and read elsewhere. Either way, the stock's upside on this year's yield could roughly range from 6% at minimum to as much as 24%.

I'm more interested in management's intention to up the dividend later this year, and on into 2012. Eagle Rock has suggested that annualized distributions could reach $1.00 per share by the close of next year. Using multiples like those above would put the stock's upside at 42% to 66%. If the company can deliver on its expectation, the stock could be in for a good run.

I'm also encouraged to see that the top three company insiders have added to their stakes since March 31, with each now holding more than 200,000 shares.

And then there are the risks...
Like any investment, this one isn't without its perils. My thesis hinges on Eagle Rock increasing, or at least maintaining, its dividend. That means Eagle Rock needs to tread carefully in the volatile energy market. While the company has about 80% of its oil hedged at $75 a barrel, and almost 100% of gas at $5.96 for the rest of 2011, it still does rely on high prices to keep the cash flowing in. It has hedged more than 70% of 2012 production at still higher prices.

Liquid capital markets are also vital for Eagle Rock, since it must finance strategic transactions through either stock or debt issuance. The company has already stated that it needs "substantial new capital" in order to realize its growth plans. Any seize-up in the markets could leave Eagle Rock unable to raise funds and boost its payouts.

Also, Eagle Rock uses hydraulic fracturing, or "fracking," in its natural gas drilling program. The process is controversial because of potential environmental damage, and many states and the federal government could more stringently regulate the process, increasing its costs. Other investments to meet environmental compliance could also lessen distributable cash.

Last, because Eagle Rock is a limited partnership, some investors want to avoid the more complicated tax calculations that its status creates. For investors who don't mind, that just spells greater opportunity and a fatter distribution.

Foolish bottom line
With a yield that's about 7.2% at current prices, Eagle Rock shares seem to have room to run in order to reach yields that are more comparable to its peers'. But given the nature of its volatile business, Eagle Rock might not be for everyone, especially income investors who need absolutely unquestionable and growing dividends quarter after quarter.

For those who demand such stable payouts, I invite you to take a look at 13 other dividend stocks in a free report from The Motley Fool called "13 High-Yielding Stocks to Buy Today." Hundreds of thousands have requested access to this special free report, and now you can access it today at no cost. To get instant access to the names of these 13 high yielders, simply click here -- it's free.

Jim Royal, Ph.D., does not own shares of any company mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (20) | Recommend This Article (72)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 11, 2011, at 5:25 PM, rjrcci wrote:

    Can Limited Partnerships be kept in a Roth IRA?

    How does this affect thier taxing?

  • Report this Comment On August 11, 2011, at 5:49 PM, yr613 wrote:

    Jim,

    Can you write about non LPs that give 4% and above dividends? Please include dividend date it pays out and frequency of dividends, please.

    yr613

  • Report this Comment On August 11, 2011, at 5:58 PM, Storyteller28 wrote:

    Jim,

    I am curious if you like UAN there are two other oil/gas trusts that have been around for quite some time and have comparable div/yields. They are:

    MV Oil Trust (MVO) (1.03/7.85) and

    Permian Basin Royalty Trust (PBT) (0.15/6.53)

    Would these two fall into the same category?

    Thanks.

    Storyteller28

  • Report this Comment On August 11, 2011, at 6:00 PM, Storyteller28 wrote:

    Apologies I meant EROC......

    Storyteller28

  • Report this Comment On August 11, 2011, at 6:07 PM, xetn wrote:

    And CQP with a current yield of about 11-12%.

  • Report this Comment On August 11, 2011, at 6:12 PM, SidNM wrote:

    For IRA purposes, limited partnership (LP) income is called UBTI (unrelated business taxable income). As I understand the rules, if the IRA makes more than $1000 per year total (from all LPs) in UBTI, then the excess is taxable. I haven't had to deal with this before, though, so I might be off on the numbers.

  • Report this Comment On August 11, 2011, at 6:46 PM, turnipseedtales wrote:

    From a non-accountant - Not all income from LP's is classified as earnings - some is return of capital and excluded from UBTI.

  • Report this Comment On August 11, 2011, at 7:06 PM, rjrcci wrote:

    If the Limited Partnership is held in a ROTH is any income taxable?

  • Report this Comment On August 11, 2011, at 7:16 PM, rlaakso wrote:

    Div. (Yield) 0.75 (1.60%)

    This comes from clicking on your provided link to EROC. This dividend yield is much less than 7.2%. What is the correct yield?

  • Report this Comment On August 11, 2011, at 8:43 PM, kanawha40 wrote:

    It would have been nice if you posted this 9 days ago since it went ex on 8/3. Not much of a div play now.

  • Report this Comment On August 11, 2011, at 8:46 PM, kanawha40 wrote:

    for rlaakso:

    stock price = 10.34 div = .75

    .75/10.34 = 7.25%

    Not sure how you got 1.60% ?????

  • Report this Comment On August 11, 2011, at 11:16 PM, zorro6204 wrote:

    I think you need a little education on EROC. It had to suspend its distribution during the crash, saddled with way too much debt and a partnership structure that created non-participating ownership units to management (NGP). The reason its distribution is targeted to $1.00 at the end of 2012 is just getting back to what passes as normal. The public units are already priced for that expectation, not the current 75 cents, so there's no reason to forecast that kind of appreciation.

    I own it, because I bought it so cheap during the restructuring with NGP. If you check out the leverage to cash flow and compare it to its midcap peers, you'll see it's at the extreme high end. I think it will dig out of the debt hole it's in, but at the present time I wouldn't exactly characterize it as a screaming buy.

  • Report this Comment On August 12, 2011, at 9:16 AM, 3chains wrote:

    CVR Energy Partners does not pay a dividend. As a limited partnership, it receives special tax treatment. If you are a unit holder, the majority of the distribution (not dividend) you receive can be counted as return of capital, and is therefore not taxed. Not taxed, that is, until your cost basis is reduced to zero.

    Still, these limited partnerships form the basis for many a (sophisticated) investor's retirement income plans. Why settle for a 4% retirement withdrawal rate when you can gather 7% or even 8% and maintain your principal? However, owning limited partnerships does make your taxes more complicated and MLPs exist in a tax haven that could be changed by Federal law.

    However, you do your readers a disservice by calling this a "dividend play". That is false. Part of the Fool's goal is to educate, and articles such as these, which have flagrant omissions of important details, do not serve that purpose.

  • Report this Comment On August 12, 2011, at 12:13 PM, ayalara wrote:

    xetn, CQP may currently have 11-12% yield but how long can it maintain that with a payout ratio over 600%, a huge debt, and rising interest rates?

  • Report this Comment On August 12, 2011, at 2:29 PM, motoruse wrote:

    I just checked NRGY's posting and the Yield is 9.94% $2.84 per share. Your not posting accurate numbers???

  • Report this Comment On August 13, 2011, at 6:45 AM, menefer wrote:

    I don't remember the specifics but my CPA told me limited partnerships should not be held in an IRA. I'd also take a look at "Fracking" before deciding to become a "partner" in this practice. Fracking is a very destructive process that has huge negative impacts on our environment and I would never own a company taking part in this practice. Watch "Gasland" the movie.

  • Report this Comment On August 13, 2011, at 6:37 PM, TMFRoyal wrote:

    Hi, yr613,

    Here's an article that describes some interesting dividend ideas that I've assembled into a portfolio.

    http://www.fool.com/investing/dividends-income/2011/08/12/th...

    All but one are non-LPs and offer a high blended yield. That should give you some ideas to mull over.

    Foolish Best,

    Jim

  • Report this Comment On August 13, 2011, at 6:49 PM, TMFRoyal wrote:

    Hi, Storyteller28,

    I'm not particularly familiar with those two names, but I'm familiar with the concept of them. The MLPs try to manage their payouts so that they grow year after year, offering stability. My understanding of the royalty trusts (like those you mention as well as MSB and GNI, as I discuss here http://www.fool.com/investing/dividends-income/2011/05/04/5-... is that they're not managed to keep steady payouts. Instead the payouts fluctuate based on the volatile underlying commodity. That can lead to big swings in the share price. MLPs try to mitigate this and offer more regularly increasing distributions, even though their cash flows often derive from similar commodities.

    On those royalty trusts, be sure to check into how long they're scheduled to live, too. They usually have a finite life, as I discuss in the attached article.

    Foolish Best,

    Jim

  • Report this Comment On August 16, 2011, at 11:02 AM, divnut wrote:

    Jim,

    Since we all know that you are fond of dividend stocks, I'd like your opinion on CenturyLink ( CTL ).

    I'm debating selling this one to take my losses and then reinvest the funds into Linn Energy ( Line ).

    Basically they both have about the same dividend payout, but Linn seems to have held it's own compared to CTL, which is continually on the downside. I got into CTL at $41, but don't mind the loss, since I feel Linn Energy has a better future .... your opinion is appreciated as always.

    Sincerely,

    Stocknut

  • Report this Comment On August 29, 2011, at 6:46 PM, gogramps wrote:

    as my first comment I will just say thanks for the help, looking forward to great things.

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