Fuel distributor Sunoco LP's (SUN -0.51%) latest payout to investors makes the yield on this master limited partnership, or MLP, a whopping 14%. Yields that high often make investors skeptical about a company's ability to sustain such a lofty payout. But this huge distribution may come less from what the company's doing, and more from the way it's incorporated.
MLP? Distribution? Units?
On April 2, Sunoco announced that it would distribute $0.8255 per unit to its investors. Anyone holding units as of May 7 would receive the distribution on May 19.
Sunoco is a wholly owned subsidiary of midstream oil-and-gas transporter Energy Transfer (ET 1.90%), and both are master limited partnerships (MLP). A company can be incorporated in many ways; publicly traded companies are mostly limited liability companies, or LLCs. Dallas-based Sunoco operates as an MLP instead, distributing refined fuel to gas stations and businesses via trucks and pipelines.
Many small things separate the two methods of incorporating, but the biggest one for investors is that partnerships don't pay corporate taxes -- the unitholders do. Instead of retaining earnings for itself, the company distributes any cash flow beyond what it needs to pay its bills directly to its unitholders. This is why MLPs often offer high-yielding distributions.
Partnerships don't issue stock, either. The instruments that trade on the exchanges are called units. (This is only a naming convention, and it doesn't mean you have to be that person at the party who goes, "Actually...")
Companies that choose to operate as MLPs are typically capital-heavy, slowly growing commodity-based companies. Examples include pipelines, energy distribution, and even some telecom companies. In the case of Sunoco, they invest that capital in warehouses and trucks for fuel distribution.
How MLPs benefit investors
Getting all that cash from the distribution every quarter is pretty much an investor's only advantage when buying into an MLP. The value of these cash distributions may also fluctuate more than most companies' dividends, since MLPs' distributions are proportional to the amount of cash flow an MLP sees.
In Sunoco's case, a 14% yield is a pretty sweet deal. Recent market volatility has brought the unit price down enough for the yield to be so high on a distribution it has reliably paid for four years. Last year, a hefty $353 million of Sunoco's $435 million cash from operations went to paying distributions to unitholders.
MLPs' big drawback
MLPs don't just pass their profits on to unitholders; they also pass along a good chunk of their tax burden. Limited partners -- meaning the unitholders of an MLP -- have to pay the company's corporate taxes as though the company's profits were their own. Unless you have a wizard for a CPA, you may have to just lop off 30% of that distribution immediately, and plan on giving the IRS that cut the end of the year.
Last year, Sunoco made nearly $16.6 billion in revenue from its fuel distribution efforts, yet booked only $313 million in net income thanks to the costs inherent in transporting fuel. Low profit margins like those are another disadvantage of operating a capital-intensive business -- not necessarily a disadvantage of MLPs themselves.
Sunoco benefits from a reliable revenue stream, since there are few other companies like it in such a capital-intensive business. The company also has a relatively low debt burden, with only $179 million in debt payments coming up this year. These factors, along with the nature of MLPs' distributions of free cash flow, will likely help to sustain the company's distribution.
As the markets recover and stock prices get bought back up, the yield for Sunoco's common units will likely dip back down to the high single digits, where most MLPs tend to yield. As long as you fully understand that, and don't mind the tax implications, buying in now might give you an excellent long-term return on your investment.