MLPs are bought to provide income. While partnerships that ooze lots of cash are tempting, be careful that your distribution is safe. Poor coverage and tiny distribution raises that keep the masses happy are a recipe for disappointment. Look for partnerships with wide coverage ratios, a disciplined approach, and a solid pipeline of capital programs. They can be the gift that keeps on giving, putting dollars in your pocket for years to come.
Income is hard to come by in today's low rate environment. The large midstream MLPs are a commonly held solution to that problem. There's a feature common to all of the three top MLP performers: growth. Magellan Midstream Partners (MMP), Enterprise Products Partners (EPD 0.18%), and Energy Transfer Partners (ETP) are all setting themselves up for future growth with a large pulse of new capital spending.
Is anything better than more money?
A higher yield means more cash. What's better than more cash from your investments?
How about more growth?
Partnerships with lower yields are usually not just holding back on you. They just have a need for that money to fuel growth, and that's a good omen for the future. Before you dismiss those low yielders, look to their capex backlog and pipeline of future projects to assess that potential.
Lots of midstream opportunities
It began with unconventional shale gas and blossomed with the emergence of the shale oil plays. Regions formerly believed to be played out or never expected to produce are now awash in production. That's changed the flow of products around the country and exposed infrastructure limitations.
That shortfall is an opportunity for midstream operators. Pipelines are being twinned, reversed and rebuilt. There are an abundance of capital projects available. Those putting lots of capital to work will see outsized growth and superior total return.
Some vital statistics for seven of the largest midstream MLPs appear in the table. Even a cursory look makes it clear that while yields are relatively similar from MLP to MLP, returns vary widely. One-year total returns—capital gains plus distributions—range from an actual loss to a very impressive 54%, with capital gains driving most of that return. What makes investors flock to these high fliers in a conservative market sector?
Simply put, it's their growth prospects. Here's a look at the top three and why they're flying high.
Magellan's Permian projects
Magellan is predominantly a refined products carrier that's diversifying its operations. Crude provides only 21% of the company's current pipeline volume, but that's gradually changing. Magellan reversed its Longhorn refined product pipeline, retasking Longhorn to carry Permian crude from Crane, TX to Houston.
Longhorn is currently on at partial volume and is expected to be on at its full 275 MBbld (thousand barrel per day) capacity mid-2014. Adding to that new volume will be a new Joint Venture with Occidental. The Bridge-Tex pipeline will eventually carry an additional 300 MBbld of Permian crude from Colorado City, TX to Texas City. Year-over-year crude volumes were up 48%, and Bridge-Tex will eventually boost crude volumes an additional 47% when it comes online.
Energy Transfer Partners' trip back from nowhere
Growth has been problematic for ETP. It's struggled for years, but growth potential has finally returned. Prior to this quarter, Energy Transfer Partners hadn't raised its distribution since August of 2008. That's the kind of stagnation that eats away at capital gains. As expected, Energy Transfer Partners' total return since the depths of the recession is last among its peer group.
Despite that uncomfortable history, a series of strategic acquisitions have improved Energy Transfer Partners' coverage ratio. Now, a fresh pile of capital expenditures is making people more confident that ETP can resume growth. For its part, management believes that this raise is just the start. The company put $2.3 billion worth of new infrastructure into service in 2012. Year end, it had another $1 billion in announced projects, with additional uncommitted projects in mind.
That's the kind of pace that drives growth. With its extremely high yield and solid prospects for some short term mojo, it's relatively easy to understand why investors bought in this last year, driving shares higher. At the same time, ETP's lackluster last five years highlights how important it is to keep an eye on your MLP's growth prospects.
Predictable growth sells at a premium
Enterprise Products Partners is as reliable as they come. Its sensibly low distribution allows plenty of fuel for future growth. That's allowed Enterprise room to raise its distribution 37 straight quarters. Year-over-year distribution growth was 6.2% in Q3.
With $7.5 billion in capital projects under construction, there are plenty of projects to continue to drive growth. Despite its large size, Enterprise delivers because of its conservative coverage strategy and corporate structure. There are no incentive distribution rights to its general partner to eat up returns. Management also dines at the same table with you, since 37% of units are insider owned.
Enterprise's growth record and strong corporate governance mean units trade at a premium. That suppresses yield, but total returns are reliably strong thanks to the growth it delivers.
Don't ignore capital gains in your income portfolio
Large dividends are nice, but the best dividend is a safe dividend. It's the capital gains driven by growth that produce the best returns over time. Magellan Midstream Partners is popping on its Permian promise, Enterprise is predictably chugging along, and Energy Transfer Partners is showing signs of life after years of stagnation. All are thriving because of their growth prospects. It's easy to focus on yield, but you could be leaving a lot on the table if you ignore growth potential. Focus on the superior total returns it provides when shopping for MLPs.
