Searching for high yields is a great way to discover new stock ideas. Sometimes, however, a high yield is only a temporary pop over the lifetime of an investment. Evaluating the sustainability of a yield is very important, but if you've discovered a young stock with little financial history, it can be a bit tougher. Today we'll examine the business models of three relatively young master limited partnerships with high yields to try and determine whether the businesses lend themselves to a lifetime of high payouts.
1. CVR Refining (NYSE:CVRR) -- 22.5% yield
As its name suggests, CVR Refining is a downstream master limited partnership in the CVR Energy (NYSE:CVI) family. It controls two refineries, one in Kansas and one in Oklahoma, as well as a pipeline and storage network.
Right off the bat we can identify two potential problems CVR Refining might have maintaining its astronomical yield. First, though its pipeline and terminal network could in theory provide stable cash flows, if one or both of its refineries were to shutdown for any reason, it would dramatically affect revenue. This is a risk for all small, independent refiners, regardless of business structure. Second, unlike pipeline MLPs that generate revenue from fee-based contracts, a refinery's success is tied very much to fluctuating oil prices, and the Brent-WTI spread.
2. Northern Tier Energy (NYSE:NTI) -- 20.4% yield
Like CVR Refining, Northern Tier is also a downstream MLP. It operates a former Marathon Petroleum refinery in St. Paul, Minn., as well as 166 SuperAmerica-branded gas station convenience stores, and SuperMom's bakery, which provides goods to the convenience stores.
Much like CVR Refining, the company will have a major problem if there is an unplanned incident at its refinery, but what about the retail/bakery side of the business? Surely that's more dependable income.
To qualify for MLP status, 90% of a partnership's income has to come from an approved business: real estate, natural resources, or minerals. All this means is that not only does the SuperMom bakery not bring in a significant amount of cash, but it can never bring in a significant amount of cash if Northern Tier wants to maintain its MLP status. Operating income for the refining segment was $141.8 million in the first quarter of this year, compared with $0.6 million in the retail segment. We have to assume that if Northern Tier wanted to be a bakery it would have done so by now, and the cash generated by SuperMom is just icing on the income cake, so to speak.
3. QR Energy (NYSE:QRE) -- 11.7% yield
QR Energy is an exploration and production MLP, focused on developing mature assets in five different oil- and gas-producing regions stretching from the Permian Basin up to central Michigan. It's a small operation, with reserves of 99.1 million barrels of oil equivalent to its name.
MLPs that are tied to commodities have to deal with the volatile nature of commodity prices, which can lead to unstable yields. In an effort to maximize stability, QR Energy employs a hedging strategy. Approximately 89% of its 2013 oil production and 93% of its 2014 oil production is hedged in an effort to stabilize cash flow.
One other thing to consider with an exploration and production MLP is that commodities are tied to inflation, which means there's little threat to the partnership if inflation rises. The flip side is that the heavy debt burdens these partnerships require to fund growth can be negatively affected if interest rates rise.
A yield might be your first introduction to a company, but it shouldn't be your last. High yields are only as good as the businesses they're built on, and though there's nothing about these three business models that guarantees they can't sustain their yields, the nature of their operations suggests it may be difficult.
Fool contributor Aimee Duffy and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.