Income investors, especially retirees, love high-yielding investments -- and who can blame them? In 2008, a study by money manager Jack Gardner found that, between 1968 and 2007, the top 100 yielding stocks in the S&P 500 outperformed the entire index by 28.4% per year.
More importantly for retirees, Mr. Gardner applied a previous study from William Bengen (the father of the 4% drawdown rule) and found that a high-yield portfolio could allow retirees to increase the amount they withdrew from their retirement portfolio by 25% to 5% annually, a finding later confirmed by Mr. Bengen himself.
For this article my goal is to present income investors with a list of high-quality investments that not only offer high and sustainable yields, but also pay monthly dividends/distributions. There are two reasons why monthly distributions are beneficial.
- If you are looking to use those monthly payouts, they help align one's income stream with one's expenses, which is of importance to retirees.
- If you are reinvesting those distributions, monthly payments increase your annualized yield. For example, a 1% monthly dividend reinvested will result in a 12.7% annualized yield compared to a 12% annual yield.
So without further ado, here are four great high-yielding companies/MLPs that I recommend all income investors consider for their diversified income portfolios.
4 stocks paying almost 1% per month
| Company/MLP | Yield | Distribution Coverage Ratio | Oil Hedges | Gas Hedges |
| Linn Energy | 13.20% | 1.1 | 50%-60% of production through 2016 | 100% of production through 2017 |
| Vanguard Natural Resources | 10% | 1.06 | 73% through 2015 | 73% through 2015 |
| Breitburn Energy Partners | 12.10% | 0.92 | 70% through 2015 | 77% through 2015 |
| Average | 11.77% | 1.03 | 66% through mid 2016 | 83% through mid 2016 |
| S&P 500 | 1.89% |
Sources: Yahoo Finance, Multpl.com, investor presentations, conference calls
As this table shows, Linn Energy (LINEQ), its non-MLP equivalent LinnCo (NASDAQ: LNCO), Vanguard Natural Resources (NASDAQ: VNR), and Breitburn Energy Partners (BBEPQ) offer more than attractive monthly yields. They also have sufficient cash flows to easily cover their distributions (except for Vanguard, which I'll address shortly), greatly increasing the probability that these distributions are sustainable in the long-term. In addition, these oil and gas producers heavily hedge their production, meaning that the recent 20% decline in oil prices isn't likely to impact their cash flows nearly as much as the market anticipates.
This creates what I believe to be an excellent buying opportunity for investors to lock in these attractive and safe yields for some of the best oil and gas MLPs in the industry.
Why the market is wrong about these MLPs
WTI Crude Oil Spot Price data by YCharts
Many investors have been taught that double digit yields are a warning sign, possibly indicating an imminent dividend cut. Judging from the recent price action of these MLPs, the market may be pricing in just such a scenario. However, allow me to explain four reasons why the market is wrong and it's safe to invest in these partnerships.
First, except for LinnCo, MLPs aren't regular corporations (LinnCo exists only to own units of Linn Energy and pay out dividends to investors who don't want/can't own an MLP). That means they pay out almost all of their earnings as distributions (tax deferred dividends) for tax purposes, which explains why this sector is famous for its generous yields.
Second, the recent price movements for these investments were purely a result of oil's recent fall. You can see from the chart that each partnership declined up to 25%-30% over the course of a month in tandem with oil's recent plunge. I track these partnerships closely, and I can assure you that no news was released during this time that fundamentally invalidates the investment theses for these MLPs. The current yield is simply a market overreaction to the recent minor correction the market experienced, along with declining oil prices that won't affect these MLPs nearly as much as the market seems to think.
This is because oil production makes up less than half of these MLPs' income source, the rest being natural gas and natural gas liquids. In addition, as the table above shows, the hedging these partnerships utilize helps to smooth out and protect the cash flow that pays the monthly distributions/dividend. This helps secure payouts and makes these investments suitable for a diversified retirement portfolio.
Just how much does this hedging help protect these MLPs' payouts?
Source: Linn Energy September 22 investor presentation
Source: Vanguard Natural Resources October 22 investor presentation
As the first image shows, Linn Energy's cash flows are 88% protected through 2016. Given the partnership's 1:1 distribution coverage ratio, this pretty increases the safety of the payout over the next 26 months, no matter what short-term energy prices do.
The second image illustrates that Vanguard, which hasn't been able to cover its distribution for the past few months due to increased investment in its Wyoming gas fields, shouldn't have a problem maintaining its payout at current energy prices of $81/barrel oil and $3.69/Mcf gas. At current energy prices the long-term payout ratio is is expected to be 1.07.
New acquisitions to lower long-term costs
As this image shows, the oil and gas MLP sector represents a nearly $2 trillion investment opportunity over the next three decades.
Linn Energy, Vanguard, and Breitburn have not only proven themselves masters of growing production and distributions over time through accretive acquisitions -- lately, they've been targeting lower cost/low decline assets to lower their costs and allow for not only more sustainable payouts, but distribution growth as well.
For example, in a series of five acquisitions/trades, Linn Energy has lowered its annual capital expenditure costs by $550 million to $650 million per year.
Similarly, Breitburn Energy has targeted high profit margin, low decline oil assets with its Postle oil field acquisition last year, which uses CO2 injection to maintain oil production at low decline rates, and this year's $3 billion buyout of competitor QR Energy (NYSE: QRE).
Meanwhile, Vanguard recently acquired over $900 million of low cost, low decline gas fields in Colorado, Texas, and Louisiana, which will increase its production by 27% at minimal cost and are immediately accretive to distributable cash flow.
Bottom line
Income investors and retirees shouldn't fear the high yields of oil and gas MLPs such as Vanguard Natural Resources, Linn Energy, and Breitburn Energy Partners. These partnerships offer generous monthly income that are most likely secure and sustainable in the long-term and also likely to grow over time. This makes these partnerships worthy of a spot on investors' income radar.
