So you want a high yield and stability all wrapped into a long-term investment that you can depend on for years to come? You're in the right place.
Often a high yield connotes some increased element of risk, which can make finding the perfect balance a bit tricky. Currently some of the highest yields in the market are found in some of the most beaten-down sectors such as steel, coal, metal miners, shippers, etc. While the double-digit yields some companies offer may look attractive, many are not reliable going forward and place the invested capital at significant risk.
But don't despair, because if you look hard enough, you can always find the needle in the haystack -- and here are three such needles with minimal risk and high yields. Not surprisingly, they are located in the MLP space, which combines tax efficiency and a predetermined distribution contract with unitholders, making for reliable income. Of all the MLPs, midstream MLPs are my personal favorites.
I often compare midstream assets to railroads. They both collect tolls on owned assets that require little maintenance. Competition is limited due to high barriers to entry, which include the capital-intensive nature of construction, regulatory hurdles that span multiple jurisdictions, and difficulty obtaining rights of way. Midstream assets are fairly insulated, even during harsh economic times, due to the inelastic nature of energy demand.
Kinder Morgan Energy Partners (NYSE: KMP) owns and operates the largest network of pipelines in the U.S. Its assets include pipelines from the Marcellus shale formation, the fastest-growing natural gas shale formation in the U.S. In 2012 it also purchased key pipelines in the northeast that supply major urban areas in New England, among them Boston, which has been hit exceptionally hard in the last couple years with harsh winter weather.
Kinder Morgan Energy Partners' unitholder distribution increases are becoming a regular occurrence. In January, Kinder Morgan Energy Partners announced a distribution increase of 5%, totaling $1.36 per unit. In March, it announced expectations to meet or exceed already high expectations for 2014. This paved the way for yet another distribution increase of 6% in April. Currently, Kinder Morgan Energy Partners yields slightly more than 7%, and it has a solid track record of reliable and consistently rising distributions spanning decades.
The general partner of Kinder Morgan Energy Partners is Kinder Morgan, which on May 25, 2012 completed the acquisition of my No. 2 selection, El Paso Pipeline Partners (EPB +0.00%).
El Paso Pipeline Partners had a very rough fourth quarter of 2013, resulting in a significant pullback in price. This created a great opportunity for the yield-oriented investor. As prices dropped and distributions remained constant, the yield (in percentage terms) per unit increased.
Currently El Paso Pipeline Partners sports a 7.6% yield, which is significantly above its five-year average of 5.9%. Now plug in a three-year distribution growth rate of 30%, and there could be real potential here.
An improving return on equity, which is among the highest in the industry, coupled with a high gross profit margin could fuel increasing distributions going forward.
But one stock that could present both high yield and significant growth going forward is Williams Partners (NYSE: WPZ), due to its focus on natural gas. Currently Williams Partners delivers 14% of the natural gas consumed in the United States, and it sports a 6.8% yield.
But that 14% delivery rate could move significantly higher if its 70% stake in the Constitution project, a proposed 121-mile interstate gas pipeline designed to connect the Marcellus shale region with desperate northeastern markets by spring 2015, can be completed.
This project is just one example of how capital expenditures are being deployed at a five-year average growth rate of 189%. With management maintaining there is a "robust growth outlook across all markets," it seems Williams Partners is content to keep that capex flowing.
The payoff
Amid an energy revolution in the U.S., pipeline assets will be utilized at increasing rates. Numerous barriers to entry exist, making new pipeline construction prohibitive. Existing assets will grow more valuable as demand for transportation grows. The inelastic nature of the business combined with the structure of an MLP contributes to the stable dividends guaranteed by a predetermined contract. This setup should provide income investors and retirees with peace of mind and consistent returns.
