There's gold in them thar pipes! Black gold, that is. And for savvy investors, there could be a lot of money in there, too.
That's because oil and gas pipeline master limited partnerships -- usually abbreviated to MLPs -- pay their investors hefty yields. Though they aren't "household names" like ExxonMobil or Chevron, this little corner of the industry is full of companies to consider buying. Today, let's look at three of them: Enterprise Products Partners (EPD 1.41%), Buckeye Partners (BPL), and Magellan Midstream Partners (MMP).
The distribution yields of energy MLPs generally outperform those in other sectors of the industry, and the stock market. Image source: Getty Images.
A sterling example
Enterprise Products Partners may be the quintessential energy MLP. The company is fairly young, only around since 1998, but it controls $52 billion in assets, including more than 50,000 miles of pipelines, as well as storage facilities, processing plants, and import/export terminals. Much of its business is fee-based: It charges other companies for moving their products through its infrastructure. That's a reliable business model that's largely immune to the day-to-day fluctuations in the price of oil.
Better for investors, the company's distribution yield -- MLPs pay "distributions" to "unitholders" rather than dividends to shareholders -- is a generous 6.6%, well above the market average.
That distribution, however, may not grow as quickly as other MLPs thanks to a recent change in the company's policies. But although distribution growth may slow, the change will allow Enterprise to self-fund more of its projects, which prevents it from having to issue new shares that dilute the value of existing shares. That conservative strategy -- coupled with the company's large size -- makes this a very safe play for income investors.
If it's yield you're after
Enterprise's 6.6% yield is nothing to sniff at, but Houston-based Buckeye Partners blows it out of the water with a current yield of 10.9%. Of course, a double-digit yield like that should immediately make investors wary. Often, high yields may not be sustainable, or may result from an investment with a price that crashed.
Sure enough, Buckeye Partners' per-unit price did decline by about 25% in 2017, pushing the yield higher. And the company's distribution coverage is much slimmer than Enterprise's. In fact, for 2017, its coverage ratio was one, meaning it had just enough cash to cover its distributions with nothing left over. Worse, in Q3 2017, the company's coverage ratio dropped below one, meaning it was unable to cover its entire distribution with cash from operations.
However, the company has a 22-year streak of annual distribution increases, beating Enterprise's streak by a year. It has never cut the company's distribution, and CEO Clark Smith indicated on the most recent earnings call that there are no plans to do so now.
"[A] temporary shortfall in coverage will not affect our distribution policy... ," Smith said. "[W]hile decisions on distribution policy are made on a quarterly basis, Buckeye currently has no intention to cut its distribution."
It's also worth noting that even if the yield was trimmed by a percentage point or two, it would still be higher than Enterprise's. Combined with Buckeye's upbeat outlook, that makes Buckeye a good choice for income investors who feel they can tolerate some risk.
Good coverage
Of course, if you don't want to stomach the risk that comes with scant distribution coverage, that's understandable. In that case, you might be interested in low-risk Magellan Midstream Partners instead. Not only did it post a healthy 1.2 times coverage in 2017, but it is known for its conservative management style and a balance sheet that's among the best in the industry.
The trade-off for that reduced risk is a yield that's lower than Enterprise's or Buckeye's -- currently 5.6%. It's worth noting that even a 5.6% yield is higher than most stock dividends, and distribution is expected to grow by 8% in 2018. CEO Michael Mears thinks that investors in Magellan really can have it all, saying in a press release:
Magellan's management understands the investment community's continued desire for solid distribution coverage. Magellan remains committed to our conservative financial profile and believes our stated goal of increasing annual distributions by 8% for 2018 and managing our distribution policy thereafter in-line with a 1.2 times annual distribution coverage ratio will provide a healthy mix of distribution growth and coverage for our investors, while also preserving our strong financial position.
And evidence indicates that Magellan can put its money where Mears' mouth is. Its 2017 distributions were 8% higher than they were in 2016, and the company has increased its distribution nearly every quarter since going public in 2001 -- with the only exceptions during the 2009 financial crisis. That makes Magellan a solid choice for continued outperformance.
Investor takeaway
For investors seeking big yields, the often-overlooked world of energy MLPs is a great place to go shopping. However, before you buy, be sure to be aware of the tax implications of MLP ownership. Because of their unique tax structure -- and income reported on a K-1 form as opposed to a 1099-DIV -- ownership could make filing your taxes more difficult, so they're certainly not for everyone.
But for those who are still interested, Enterprise Products Partners, Buckeye Partners, and Magellan Midstream Partners currently offer fantastic yields and upbeat 2018 outlooks. They're certainly worth considering as part of a balanced portfolio.
