Despite the Quick Profit, This Is a Risky Investment Strategy for Retirees

Photo credit: Flickr/TaxCredits.net 

Last week, investors in PetroLogistics (NYSE: PDH) were pleasantly surprised by a $2.1 buyout by Koch Industries. Koch offered $14 per unit, which is $1.00 higher than the company's units were trading for before the announcement was made. While PetroLogistics investors made a fast return, there's a big risk for retirees investing in a company like PetroLogistics. That's because the company's revenue is tied to just one asset. Because of this, retirees investing in similar one-asset companies like Terra Nitrogen (NYSE: TNH) and Northern Tier Energy (NYSE: NTI) are really taking on too much risk.

Lacking security
PetroLogistics' sole asset is the world's largest propane dehydrogenation plant. It's a great asset, as it turns cheap natural gas into propylene, which is a key petrochemical used in making plastics. That being said, PetroLogistics owned just that one plant, which is great when it's up and running. The problem is that the plant didn't always run at full-production capacity. Because of issues with production and overall profits, PetroLogistics, which is an MLP, didn't always pay out steady distribution to its investors. For retirees looking for steady income, this was a problem.

Since 2012 PetroLogistics' quarterly distribution has fluctuated rather wildly. The distribution has been as high as $0.67 per unit to as low as $0.21 per unit. While the overall distribution yield was high, it came with the big risk that the payout would fluctuate from quarter to quarter. So, for retirees seeking steady income, the company's variable distribution was really much too risky of an investment to hold.

Same risk applies here
That's why I'd caution retirees to stay away from investing too much of their portfolio in companies like Terra Nitrogen and Northern Tier Energy. While both offer compelling current yields, the one-asset nature of these MLPs adds an extra layer of risk that's just too risky for many retirees to consider.

Terra Nitrogen's main asset, for example, is a nitrogen manufacturing facility in Oklahoma. While it's a great asset that, like PetroLogistics, is profiting from cheap natural gas as a feedstock, the lack of diversification beyond that one asset is a big risk for investors. That asset can be affected by natural gas prices, mechanical issues, or even weather problems that could put its distribution on ice for a while. Further, as the following graphic shows, Terra Nitrogen's distribution has varied wildly during the past two decades.

Source: Terra Nitrogen Website

It's a similar story at Northern Tier Energy. The company's main asset is the St. Paul Park Refinery, which is an 89,500-barrel-per-day refinery in Minnesota. While Northern Tier Energy owns 17% of the Minnesota Pipeline, some storage and transportation assets, as well as 164 company-operated SuperAmerica brand convenience stores, the refinery is its core asset. Again, it's a great asset that's well positioned to process cheap Bakken and Canadian crude oil. However, it's an asset that can be affected by mechanical issues and margins as the following side shows.

Source: Northern Tier Energy Investor Presentation (Link opens a PDF) 

As this slide shows, the company's refinery throughput and margins can fluctuate from year to year. Meanwhile, its capital and turnaround expenses can eat into profits, as well. This is why Northern Tier Energy's distribution has varied so widely. During the past year-and-a-half, the distribution has been as high as $1.48 per unit to as low as $0.31 per unit. Needless to say, a retiree who was relying on income from Northern Tier Energy to pay the bills could struggle to make ends meet when the company has a bad quarter.

Investor takeaway
Some investments just weren't created with retirees in mind. Variable distribution MLPs that only own one main asset, like PetroLogistics, Northern Tier Energy, and Terra Nitrogen, are among that group that are just too risky to be counted on as a core holding in a retiree's portfolio. There are plenty of other MLPs that offer better diversification and more secure distributions that would be a better investment for a retiree.