Wednesday, May 30, 2012

Why I am replacing ConEdison (ED) with ONEOK Partners (OKS)

I am a passive dividend investor. I purchase quality dividend stocks, with the expectations that I will hold on for decades. I do monitor my investments however, and typically sell when one of these three factors occurs. I am not a big fan of active dividend investing, since it leads to paying taxes on capital gains, transaction costs as well as opens me for the opportunity to make mistakes. Buying a stock that will perform much worse than the stock it just replaced in my portfolio, is one of the items in my decision process that might prevent me from active portfolio management. Dividend investing is not a black and white process however, which is why investors should sometimes act to break their rules, if the right opportunity arises.

Over the past month I sold almost my entire position in Con Edison (ED) realizing a substantial profit. I used the proceeds to purchase units of ONEOK Partners (OKS). This move resulted in an immediate increase of 10% to the dividend income of the 1.20% or so of my portfolio that was invested in Con Edison (ED).

I had not added any funds to Con Edison since 2010. The low interest rate environment has pushed many investors to chase high yielding utilities stocks to valuation levels that no longer make sense. Currently, this New York based utility yields 4.10%, and trades at a P/E ratio of 17 times earnings. My average cost on the stock was $44.61, bringing my effective yield on cost to be 5.40%. Unfortunately, Consolidated Edison has been unable to grow earnings much over the past decade, as EPS increased from $3.13 in 2002 to $3.57 in 2011. The annual dividend has been increased at an annual rate of 2 cents/share since 1996, and is projected to reach $2.44/share in 2013. As a regulated utility, Con Edison’s profits are limited by the amount it can charge its customers, which in turn is determined by regulators. Lately, regulators haven’t been particularly generous about utility price hikes, which does not bode well for revenue and profit growth in the long run. To summarize, I do not see much upside in ConEdison in the current environment, and I do not think that total returns over the next decade are going to be much larger than the amount of current dividend yield. That being said, I believe the company is a decent hold, particularly for investors who have purchased the stock below $50/share, as I believe that the dividend will be paid and increased at a super slow rate in the foreseeable future. In a dividend portfolio, having some exposure to the utilities sector could provide refuge to investors if the economy declines again.

The question on my mind was what I should invest the proceeds from Con Edison in. I decided to add to my position in ONEOK Partners (OKS), which has a slightly higher yield, but offers a much faster distribution growth. The partnership is undergoing rapid expansion in the Mid Continent and Gulf Coast, bringing income generating assets online, and generating strong organic growth by satisfying demand for Natural Gas Liquids. The partnership is eyeing a 15% - 20% growth in distributions in 2013 and 2014. The partnership paid $609.45 million in distributions in 2011, while its distributable cash flow amounted to $946 million, which was more than sufficient distribution coverage.

ONEOK Partners, L.P. (NYSE: OKS) is one of the largest publicly traded master limited partnerships, and is a leader in the gathering, processing, storage and transportation of natural gas in the U.S. and owns one of the nation's premier natural gas liquids (NGL) systems, connecting NGL supply in the Mid-Continent and Rocky Mountain regions with key market centers. Its general partner is a wholly owned subsidiary of ONEOK, Inc. (NYSE: OKE), a diversified energy company, which owns 43.4 percent of the overall partnership interest. The General Partner has an incentive to keep growing ONEOK Partners (OKS), in order to generate higher distributions themselves.

Investors in Oneok Partners are called limited partners, and shares are called units. Master Limited Partnerships are pass through entities, and as a result are not taxed by the IRS. Their income and gains/losses flow through on the individual partners tax returns proportionately. Partners receive a K-1 form each year, which is slightly more complicated than a 1099 –Div form. However, Oneok Partners did a very good job of sending me a detailed tax package support, which spelled out exactly what tax forms I needed, as well as exactly where I should input the various amounts included in my K-1 form. Best of all, I had to pay no tax on the amount of distributions I received in 2011. Most partnership distributions decrease one’s basis, and once this happens, partners would have to pay ordinary income taxes on most of the income that is distributed to them. However, certain types of income that the partnership distributes, such as capital gains on property sold, is taxable as capital gains. ONEOK also did a very good job in spelling out the amount of income/loss I had as a partner in each state it does business in.

Back in 2011, I sold my position in ONEOK Inc (OKE) at $72.35/share, and used it to acquire units in ONEOK Partners (OKS) at an average price of $41.71/unit. My average cost on ONEOK Inc (OKE) was $54.15/share. With this move, I was able to double the amount of distributions, attributable to this portion of my portfolio. One year later, I am more than satisfied with the total returns and distribution growth of ONEOK Partners (OKS). By replacing ConEdison with ONEOK Partners, I will further manage to increase amount of distributions, while further consolidating my position in the partnership.

Full Disclosure: Long ED and OKS

Relevant Articles:

- Replacing appreciated investments with higher yielding stocks
- Active Dividend Growth Investing
- Dividend Investing is not a black or white process
- Master Limited Partnerships: An Island of Opportunity for Dividend Investors

3 comments:

  1. Saying a K-1 is "slightly more complicated" than a 1099-DIV is like saying my house is "slightly smaller" than the Empire State Building.

    I don't mean to scare anyone off, but MLPs are complicated. You get into things like passive activities (can't deduct the losses unless you have gains), at-risk limitations, etc. And make sure to keep good records of basis when you go to sell them (most people don't). Digging through years of old K-1s to reconstruct it is no fun. (I'm a CPA and have done it a few times.)

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  2. Hi DGI,
    Do you ever consider investing in BDCs? -They usually come with very high dividends. - Thanks, Joe

    ReplyDelete
  3. I strongly disagree that MLP's are complicated. K-1's are also not a big deal. Not deducting losses unless you have gains is standard accounting practice. And finally any decent brokerage house keeps, by federal regulation, a record of your purchases.

    The biggest issue with MLP's is that the distributions are return of capital mostly and that decreases your cost basis. The tax is deferred. The only way to 'win' is to die and leave the MLP's to your heirs who will get to use a 'step-up' basis for cost. And then there is no tax due.

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