Showing posts with label mlp. Show all posts
Showing posts with label mlp. Show all posts

Monday, August 18, 2014

Kinder Morgan Limited Partners Could Face Steep Tax Bills

As I touched upon earlier last week, Kinder Morgan is trying to combine all companies under a C-Corp corporate umbrella of Kinder Morgan Inc (KMI). The shareholders of Kinder Morgan Management LLC (KMR) will receive shares of Kinder Morgan Inc, which would not be a taxable event for them. Unitholders in Kinder Morgan Energy Partners (KMP) and El Paso Pipeline Partners (EPB) will receive cash and Kinder Morgan Inc shares in exchange for their units.  This will create a taxable event for limited partners.

Typically, when you purchase units in a master limited partnership, most of initial distributions are treated as a return of capital. Those do not result in a taxable income for the year, but they decrease the cost basis of the unitholder. Once the cost basis reaches zero, the distributions are taxed at long-term capital gains rates. If the unitholder passes away, their children receive a step up basis in the units.

Is your head spinning yet? Basically, if you purchased Kinder Morgan Energy Partners (KMP) at the end of 2002 for about $35, you would have received $46.30 in distributions since then. The first $35 in distributions would have been treated as a return of capital and therefore been non-taxable in the year received. However, they would be tax-deferred only, since a sale would have triggered a taxable event and those would have been payable at ordinary income taxes. The next $11.30 in distributions received would have been treated as long-term capital gains, which receive preferential tax treatment.

If our limited partner decided to sell at $95 today, they would essentially have a long-term capital gain of $60/unit and an ordinary gain of $35/unit. The long-term capital gain will be taxed at 15% for most unitholders, and will result in tax of $9. The ordinary income gain of $35 would be taxable at ordinary income tax rates. Let’s say you were married, and both you and your spouse were in the 25% tax bracket. This would mean that you owe $8.75 in tax on that depreciation recapture. So in total, our limited partner would owe tax of $17.75.

Unfortunately, for those limited partners of Kinder Morgan Energy Partners and El Paso Energy Partners, the acquisition by Kinder Morgan Inc could result in triggering of tax liabilities.

When you sell your units for cash or have them exchanged into shares of Kinder Morgan, this creates a taxable event. In essence, the act of exchanging your Kinder Morgan Energy Partners units for Kinder Morgan Inc stock is treated as if you sold your units for cash. Therefore, a tax is due on all recaptured depreciation at ordinary income tax rates, and at long-term capital gains rates for anything in excess of the purchase price and value received at the time of conversion to corporation. On the bright side of course, if you received $95 in Kinder Morgan shares for your Kinder Morgan Energy Units worth $95, your basis in the shares will be $95. However, now I see why Kinder Morgan decided to offer cash to unitholders. Most will need that cash to pay their taxes on deferred gains.

Of course, you didn’t buy Kinder Morgan Partnership Units just for the tax benefits, did you? You bought Kinder Morgan because you believe in management, you believe you are getting in at a good price, and you believe that in the future the business will be able to generate more cash and pay more back to you. If you choose to hold onto your Kinder Morgan shares however, projections are for dividends to increase by 10%/year through 2020, which is not a bad rate of growth, considering the already high yield on the stock. I like that the incentives of shareholders are aligned with those of the main shareholder Richard Kinder, who i believe to be The Warren Buffett of Energy.

The acquisition of limited partnerships will increase the basis in pipeline and other fixed assets that Kinder Morgan Inc will now own. Kinder Morgan will get to depreciate those assets as if they were brand new assets. As a result, there will be $20 billion in tax savings from the proposed deal. In addition, the structure will be more streamlined, will have lower cost of capital because there won’t be those incentive distribution rights any more.

The lower cost of capital would mean that projects will generate more money right away, and the company would not have to dilute existing holders, because it sells too many units to grow. Retaining some cash flow for funding growth seems like a smart strategy. The company still needs growth projects in order to generate growth to pay for higher distributions down the road of course. Now with a single entity like Kinder Morgan Inc, it could use its stock as currency for further acquisitions. Given the track record of Richard Kinder, I am confident that he would be able to integrate any acquired companies into the Kinder Morgan umbrella quite successfully, while realizing synergies, higher profits for shareholders.

Full Disclosure: Long KMR and KMI

Relevant Articles:

Kinder Morgan to Merge Partnerships into One Company
Richard Kinder: The Warren Buffett of Energy
Kinder Morgan Partners (KMP) for High Yield and Solid Distributions Growth
Kinder Morgan Partners – One Company three ways to invest in it
General vs Limited Partners in MLP's
Master Limited Partnerships (MLPs) – an island of opportunity for dividend investors

Sunday, August 10, 2014

Kinder Morgan to Merge Partnerships into One Company

The Kinder Morgan group of companies issued a press release today, which discussed some interesting new developments. Basically, the general partner being Kinder Morgan Inc (KMI) will be acquiring the master limited partner structures such as Kinder Morgan Energy Partners (KMP), Kinder Morgan Management LLC (KMR) and El Paso Pipeline Partners (EPB). There will no longer be any master limited partnerships involved with the Kinder Morgan name, which would simplify things and roll all assets under one corporation. For a brief overview of the current structure, please check this article.

The limited partners in Kinder Morgan Energy Partners (KMP) will receive 2.1931 KMI shares and $10.77 in cash for each unit they hold. The limited partners of El Paso Pipeline Partners (EPB) will receive .9451 KMI shares and $4.65 in cash for each unit they hold. While I doubt that the KMI shares received would be taxable, because of the like-kind nature of this exchange, I believe that the cash will be a taxable event for some unitholders.

The shareholders in Kinder Morgan Management LLC (KMR) will receive 2.4849 KMI shares for each share of KMR. This would essentially eliminate the gap between KMR and KMP, which has existed for the past several years. This was one of the reasons why I initially purchased KMR over KMP – lower prices, plus possibility for tax-free compounding of distributions, without the added complexity of K-1 tax forms that partnerships generate around tax time.

Before the deal was announced, I was actually expecting that the limited partnerships will take over the general partner, or that the general partner Kinder Morgan Inc would merge into them, thus creating a one giant MLP. Instead, Kinder Morgan Inc will be subject to double taxation as a result of this deal, and also would no longer be enjoying the sweet incentive-distribution rights as a general partner. Those IDR’s will be eliminated, thus lowering cost of capital. However, the company would be enjoying some nice depreciation benefits, which would shelter a portion of income. The drawback is that now most of distributions would no longer pass-through directly to unitholders of limited partner units. On the contrary, the corporation would have to pay taxes on corporate income level, and then when it sends those dividend checks to shareholders, they would also be liable for any taxes.

The other drawback for other investors could be that the yields they will generate will be lower. This is because KMP yields 6.90% while EPB yields 7.50%.Even at the higher dividend of $2/share, KMI yields 5.50% at best.

One positive behind the deal is that there won’t be the need to constantly issue new shares as much as with the MLP structure. Therefore, existing shareholders would not be diluted as much as with other MLPs. In addition, it would be much easier for the company to operate as one, rather than four complicated structures. This would make it easier to move aggressively on acquisitions, which would further boost growth.

The other competitive advantage for the new structure would be that it won’t have to distribute all cash flow to unitholders for distributions, but could actually choose to reinvest a portion in the business. That should reduce need for debt, although it won’t eliminate it. The main attraction of course is that the elimination of the IDR's will make cost of capital lower.

However, the company now expects annual dividends to hit $2/share in 2015, and then grow by 10%/year through 2020. I don’t know about you, but this sounds like a pretty sweet deal, if it could be realized. Based on my calculations, Kinder Morgan Inc could end up paying $3.22/share by 2020, which is an yield on cost of roughly 9%. I believe this is a doable target, because the new company will be retaining more cash to invest in the business, and it will be able to better focus on finding acquisitions for further growth.

After this deal is closed, Kinder Morgan will be the largest position in my dividend portfolio. Kinder Morgan Inc (KMI) was already one of my largest four positions. Kinder Morgan Management LLC (KMR) has also been a decent size position. This is why I haven’t added to Kinder Morgan Inc for over an year and a half. Because this position will account for much more than any other position in my portfolio, and because its high current yield is higher than the yield on my portfolio as a whole, I doubt I would buy more shares for at least one or two years from now. The only exception is one of my IRA accounts, where dividends are reinvested automatically. As I have explained earlier, it makes sense to do so given the fact that this account is not going to get any future cash contributions in the future.

Full Disclosure: Long KMI, KMR

Relevant Articles:

Kinder Morgan Partners – One Company three ways to invest in it
Richard Kinder: The Warren Buffett of Energy
I admire Investors with Skin in the Game
Master Limited Partnerships (MLPs) – an island of opportunity for dividend investors
General vs Limited Partners in MLP's
MLPs for tax-deferred accounts

Monday, July 22, 2013

Why did I sell Enterprise Product Partners (EPD)

I recently sold two-thirds of my position in Enterprise Product Partners (EPD). I laid out all the facts behind the sale in the original article. However, several readers missed the facts, and instead utilized their opinions and their own experiences in order to negate the article.

Now I never pay attention to other people’s mere opinions, because I firmly believe that comments on my investing strategy do not really add much to my investment performance results. This is a crude paraphrase of Warren Buffett’s famous quote that "You Pay a High Price for Cheery Consensus“ ( I am no Buffett though) .However, when I am presented with facts, rather than opinions, I always listen.

I typically try to hold securities" forever", although I tend to avoid holding too tight if I can find a better play(s) that is of similar quality, yet can provide me with more bang for my buck. Kinder Morgan Inc (KMI), Kinder Morgan Management LLC (KMR) and Oneok Partners (OKS) fit the profile. If other comparable MLPs were trading similarly to Enterprise Product Partners (EPD), I would have been more than happy to hold. I am also trying to maintain flexibility as well, just in case. Dividend investing is not a black or white activity, which is why rigid rules based systems never really hold up in real life.

Many of the arguments against my selling related to the “onerous tax” picture of selling. I often have mentioned that I never care about taxation when I sell. More investment sins are probably committed by otherwise quite intelligent people, because of "tax considerations" than from any other cause. Anyone that puts taxes before investment quality is just asking for trouble. I have known of many investors who never sold their employer stock at a gain, in order to avoid paying taxes. Well, lucky for most of them, the gains had turned into losses by the time they needed the money to put a downpayment on a house, send a kid to college or retire from the workforce. So much for putting taxes before your investment thesis.

However, as investing is more of a gray area than black or white, I am also open to a more softer approach to tax management. For example, this year I began maxing out my 401 (k). I also maxed out SEP IRA for 2012 right around April 15, 2013. Because I am still in the accumulation phase of building my nest egg, I have come to realize that taxable MLP’s with their K-1 forms might not be the most optimal investment from a tax standpoint for me right now. This is because I don’t really plan on using this money to live off for several years from now. As a result, I might be better off in an entity like Kinder Morgan Management LLC (KMR), than a Kinder Morgan Energy Partners (KMP). It doesn’t make sense to be collecting distribution income today from an MLP, when this reduces taxable base and my retirement is years from now.

Several individuals reaching out to me about the post, had mentioned that they had purchased Enterprise Product Partners (EPD) at prices such as $20 - $30/unit. Because they had held the partnership for so long, their basis was probably approaching zero. As a result, they viewed my selling of Enterprise Product Partners (EPD) as a bad idea. However, they thought of it as a bad idea, because they didn't read the facts of the article, that was pertaining to my situation. Instead they chose to be viewing it from their own position. Ignoring facts is typical in most aspects of life, as humans are emotional creatures that respond better to emotion that factual evidence. Ignoring the facts is what separates winning investors from losing one.

Basis in master limited partnerships can keep dropping over time, because depreciation typically is higher than income, and therefore the net result is a distribution that is classified as return of capital by the tax authorities. As a result, this distribution decreases your tax basis. This means that as long as your basis is above zero, any distributions you receive from an MLP would not be taxed.

If you decide to sell however, your tax situation is very interesting. If you bought at $40/unit in 2011, and sold at 63.73/unit in 2013 your gain is more than the $23.73 difference. This is because you likely earned about $6.27/unit in distributions during that period ( approximations are made in this example in order to end up with nice rounded numbers that are easier to digest). As a result, you owe about $30/unit to tax authorities. $6.27 of this would be taxed as ordinary income, while $23.73 would be taxed as a long-term capital gain.

If your head is spinning from these numbers, you are not alone. You see, the biggest reason investors have against selling Enterprise Product Partners (EPD) is because of taxes. With a basis of about $40 something/unit, and gain of about $20 capital and $6 - $7 return of capital, I am doing the smart thing of cutting my “stake” early, and moving into other entities that can provide me with slightly better growth, yield and total returns, minus the tax nightmares. It is just intriguing to me that some investors are preaching against selling because the taxes were onerous, yet they did not register the flaw in their thinking.

It therefore seems smarter to sell Enterprise Product Partners (EPD) when I have a $6-$7 ordinary gain and buy a security with slightly better characteristics (KMI and KMR) and pay the least amount of taxes, than do this in 10 – 15 years, when my basis will be zero. After your basis is exhausted, and you don’t add any more funds, you will have to pay ordinary income taxes on the amount you receive as distributions.

I am still holding onto approximately 33-34% of original position in Enterprise Product Partners (EPD). The partnership could easily end up yielding less than 4%, which could be a sell signal. If the partnership yields less than 4% however, I might consider dropping my stake altogether. I also am going to keep my options open, and could decide to sell by end of 2013 and replace it with Kinder Morgan Management LLC (KMR) for example.

Astute readers would notice that for my original position of Enterprise Product Partners (EPD), I am left with about 50-55% in MLP entities for this position( EPD and OKS). They are subject to these onerous MLP K-1 filings that so many other investors are losing sleepless nights over. Of course, as I mentioned before, the decision to sell was based on valuation, although taxes did come out second in the decision.

I found the Enterprise Product Partners (EPD) partnership to be richly valued, and I liked the fact that there are alternatives that can provide me with better values. In addition, because of adding to Kinder Morgan Inc (KMI) and Kinder Morgan Management LLC (KMR), I am going to have less of a hassle with MLP filings. Kinder Morgan Inc is going to deliver higher dividend growth, and possibly high total returns - at 4% yield growing 10% is much better than a 4.30% yield growing 6%. Kinder Morgan Inc is a corporation, and therefore I am dealing with 1099 at tax time, versus K-1s.

Kinder Morgan Management LLC (KMR) is a better choice than Enterprise Product Partners (EPD)  because it pays distributions in extra stock, which is not a taxable event. It also yields moreand would likely have slightly higher distributions growth. In addition KMR trades at a discount to Kinder Morgan Energy Partners (KMP), which is closely tracks ( although not as high as a few years ago). So no K-1 forms here either.

ONEOK Partners (OKS) is more of a value play here, as it is not loved by investors at present times. However, if the partnership growth plans materialize, you could be very positively surprised in 4-5 years. Sure, there are K-1s there, but I believe it will do much better than EPD over time.

Relevant Articles:

Check Out the complete Archive of Articles
How to Increase Current Yields with Master Limited Partnerships
ONEOK Partners (OKS) Dividend Stock Analysis
Kinder Morgan Partners – One Company three ways to invest in it
Kinder Morgan Partners (KMP) for High Yield and Solid Distributions Growth

Tuesday, July 16, 2013

How to Increase Current Yields with Master Limited Partnerships

As a buy and hold investor, I usually refrain from selling, unless there is something drastic like a dividend cut. Over the past year however, I have tried to sell some legacy positions, which either didn’t perform well or were overvalued with similar companies available at cheaper prices. The transaction I did last week was an example of this, as I replaced a position with other similar equities, without sacrificing quality.

Last week, I sold two-thirds of my position in Enterprise Product Partners (EPD). The units had reached a current yield of 4.30%, which was a little low for an MLP, even in the current low interest environment. Over the past five years, this partnership has managed to boost distributions by 5.70%/year. I believe EPD is a high quality partnership, which will likely produce very good distribution hikes over the next decade. However, I believe that there are better values out there in the MLP space. In general, despite low interest rates today, I do not find pass-through entities yielding 4% to be a good value, although they could be decent holds if no other opportunities along the quality curve are available.

The good thing about this transaction was that I was able to find values in the same sector, without sacrificing quality. I split the proceeds in three equal portions, and purchased the following securities:

The first lot was allocated to shares of Kinder Morgan Inc (KMI), which owns the general partnership interests in Kinder Morgan Partners (KMP) and El Paso Pipeline Partners (EPB). The company also owns limited partnership interests in KMP and EPB. As a general partner, Kinder Morgan Inc receives 50% of the distributions growth above a certain threshold. Therefore, because the underlying partnership has been growing over the past several years, Kinder Morgan Inc is expecting to be able to boost dividends in the low double digits for several years to come. Currently, the stock yields 3.90%.

One third was invested in Kinder Morgan Management LLC (KMR). Kinder Morgan Energy Partners has managed to boost distributions by 7.40%/year, over the past five years. In addition, the partnership is expecting very decent distributions growth over the next several years. However, instead of purchasing the partnership units (KMP), I invested in the LLC, which is treated like a corporation (KMR). Kinder Morgan Management LLC (KMR) owns units of Kinder Morgan Energy Partners (KMP). The LLC pays distributions in stock, which eliminates the taxable event in the eyes of the Internal Revenue Service. As a result, for investors in the accumulation stage, investing in Kinder Morgan Management LLC (KMR) is a better alternative to investing in Kinder Morgan Energy Partners (KMP). KMR has always traded at a discount to KMP, which should magnify total returns going forward. For every share of KMR, there is a partnership unit of KMP. The yield on Kinder Morgan Energy Partners is 5.90%.

The last portion was allocated to ONEOK Partners (OKS), which operates Natural Gas Gathering and Processing, Natural Gas Pipelines, and Natural Gas Liquids. The partnership has managed to boost distributions by 5.40% over the past five years. ONEOK Partners is undergoing a massive capital investment phase, which should result in much higher distribution growth over the next several years. Currently, the partnership yields 5.60%. Check my analysis of ONEOK Partners.

In essence, I view this swap as maintaining quality of ownership stakes by staying in the same sector, while achieving better yields and similar if not slightly better growth prospects.

My position in Enterprise Product Partners was initiated in the low 40s in 2011, and therefore by selling in the low to mid 60s, I am probably going to face decent sized capital gains hit. MLP distributions are usually tax-deferred, and they reduce your current basis. As a result, while you do not pay taxes on the majority of distributions during your holding period, you get to pay them when you sell. For example, if you bought EPD at $40/unit in 2011, and received $6.27 in distributions over the next 2 years, your cost basis would have been reduced to approximately $33.73/unit. Therefore, if you sold at $63.73/unit, you would owe taxes on $30/unit, not $23.73/unit.

The goal of successful investment is to identify great companies, which can provide promising returns through distributions and capital gains. Tax considerations should come secondary for investors. If you do not like something about a position, and the only reason you are not selling is because of the potential tax hit you would take, then you are asking for trouble. If you are correct about the negative investment outcome and do not do anything about it, you would be able to deduct your losses later on, before you move on.

Overall, I replaced an equity stake that grows at 5.7% and yields 4.30%, with three ownership stakes that deliver a better current yield in total. In addition, the new stakes will be able to generate a higher growth in distributions over the next few years.

Full Disclosure: Long EPD, KMI, KMR, OKS

Relevant Articles:

Check Out the complete Archive of Articles
Enterprise Products Partners (EPD): A Pipeline Cash Machine
ONEOK Partners (OKS) Dividend Stock Analysis
Kinder Morgan Partners (KMP) for High Yield and Solid Distributions Growth
Kinder Morgan Partners – One Company three ways to invest in it

Monday, April 16, 2012

MLP’s deliver consistent distribution increases

The list of dividend increases over the past week was dominated by Master Limited Partnerships. Most of the MLPs are pipeline companies, which are engaged in the transportation of oil and natural gas from the source to the final customer. Pipeline MLPs have shown a consistent growth in quarterly distributions as a group, despite the economic turbulence we have lived under over the past five years. This is mostly due to the fact that most pipelines are natural monopolies in a given area, and they typically manage to increase fees each year at least by the rate of inflation. In addition, while prices of the commodities they transport fluctuate on a daily basis, aggregate volumes of oil and gas in the US is pretty stable year over year.

The following dividend growth companies raised distributions over the past week:

Plains All American Pipeline, L.P. (PAA), through its subsidiaries, engages in the transportation, storage, terminalling, and marketing of crude oil, refined products, and liquid petroleum gas (LPG) products in the United States and Canada. The company operates in three segments: Transportation, Facilities, and Supply and Logistics. This dividend achiever raised quarterly distributions to $1.045/unit, which was 7.70% above the distribution paid in the same time in 2011. Plains All American Pipeline has increased distributions for 12years in a row. Yield: 5.30%

Genesis Energy, L.P. (GEL) operates in the midstream segment of the oil and gas industry in the Gulf Coast region of the United States. It operates through three divisions: Pipeline Transportation, Refinery Services, and Supply and Logistics. This MLP raised quarterly distributions to 45 cents/unit, which was 10.40% above the distribution paid in the same time in 2011. Genesis Energy has increased distributions for 9 years in a row. Yield: 5.80%

Targa Resources Partners LP (NGLS) provides midstream natural gas and natural gas liquid (NGL) services in the United States. The company operates in two divisions, Natural Gas Gathering and Processing, and Logistics and Marketing. This MLP raised quarterly distributions to 62.25 cents/unit, which was 11.70% above the distribution paid in the same time in 2011. Targa Resources Partners has increased distributions for 7 years in a row. Yield: 6.10%

Tanger Factory Outlet Centers, Inc. is a REIT, which engages in acquiring, developing, owning, operating, and managing factory outlet shopping centers. The company raised its quarterly dividend by 5% to 21 cents/share. This marked the 19th consecutive annual dividend increase for this dividend achiever. Yield: 2.90%

Healthcare Services Group, Inc. (HCSG), together with its subsidiaries, provides housekeeping, laundry, linen, facility maintenance, and dietary services to nursing homes, retirement complexes, rehabilitation centers, and hospitals in the United States. It operates in two segments, Housekeeping and Dietary. The company raised its quarterly dividend to 16.25 cents/share, which was 3.20% above the distribution paid in the same period in 2011. Healthcare Services Group has raised dividends for 10 years in row. Yield: 3.20%

While MLPs have been great performers over the past decade, several factors could bring a halt to their distribution growth. Since most MLPs distribute all of their cash flows to unitholders, the only way they could grow is by selling additional debt or units in the markets. If interest rates increase, this will increase the cost of capital for these companies, and will reduce investor appetite for the sector.

Full Disclosure: None

Relevant Articles:

Monday, October 17, 2011

Enterprise Product Partners (EPD) – quietly building wealth for unitholders

Enterprise Products Partners L.P. (EPD) provides midstream energy services to producers and consumers of natural gas, NGLs, crude oil, refined products, and petrochemicals in North America.

Last week, Enterprise Product Partners declared its 29th consecutive quarterly distribution increase. The board of directors of the General Partner increased the distribution rate to 61.25 cents/unit. This represented a 5.20% increase over the distribution paid in the third quarter of 2010. This dividend achiever has increased distributions in every year since 1999. As a unitholder, it pays well to get paid a high yield while also having my income increased over time. Check my analysis of the partnership.

Enterprise Product Partners is organized as a master limited partnership, where income and cash are proportionally distributed to unitholders. Since it is a partnership, shareholders are called unitholders and dividends are called distributions. With MLPs, typically only a portion of the cash distributions is taxed as ordinary income. The remainder represents a tax deferred distribution, which reduces the partner’s cost basis in the partnership. If the partner sells, this would translate into higher capital gains taxes they have to pay to the IRS.

The return of capital deferral is a result of depreciation on the massive capital assets that the partnership owns. Just like with real-estate, even if pipelines are fully depreciated on the company’s books, they will likely be in a good condition for continued exploitation. As a result, an important metric to use with MLPs is distributable cash flows. The partnership maintained a distribution payout ratio of 77% in 2010. Enterprise is also one of the few partnerships which have no incentive distributions rights for the general partner.

I will be considering adding to my position in the partnership on any price declines. The yield of 5.70%, coupled with solid distribution growth potential make this company a buy.

Full Disclosure: Long EPD

Relevant Articles:

- Enterprise Products Partners L.P. (EPD) Dividend Stock Analysis
- Master Limited Partnerships (MLPs) – an island of opportunity for dividend investors
- General vs Limited Partners in MLP's
- MLPs for tax-deferred accounts

Friday, November 5, 2010

Enterprise Products Partners L.P. (EPD) Dividend Stock Analysis

Enterprise Products Partners L.P. provides a range of services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil, refined products, and petrochemicals in the continental United States, Canada, and Gulf of Mexico. This dividend achiever has raised distributions for thirteen consecutive years. As a master limited partnership, the company doesn’t pay taxes at the corporate level. The tax bill is paid by the unitholders, which receive K-1 forms that give detailed explanations on how to report each significant item of income that Enterprise Product Partners has generated.

Over the past decade, this dividend stock has delivered a total return of 18.30% annually.
Over the past decade, Enterprise Products Partners L.P. has managed to increase cash flow per share by 10.20% annually. The beauty of pipeline MLPs is that they generate stable revenues, as they have virtual monopoly on oil and gas transportation for a particular pipeline in a particular region. In addition to that, volumes transported of natural gas or oil are much less volatile than the price of the underlying commodity.

The company has managed to raise annual distributions at a rate of 8.60% annually over the past decade. At 9%, dividends double every eight years. The current rate of distribution is double the amount paid every quarter nine years ago.

The company’s cashflow payout ratio has steadily decreased over the past decade from its highs reached in the early 2000s. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
As a master limited partnership, Enterprise Product Partners tends to distribute more than what it earns in a given year. Because it distributes almost all of its cashflow to unitholders, the company grows by issuing additional units or taking on debt.
There are several risks to EPD in particular. The first risk is that interest rates could increase, which will make master limited partnerships unattractive relative to risk-free fixed income instruments. This could also increase the cost of capital for the company and hinder future growth. Another risk with master limited partnerships is that the government could decide to abolish the MLP structure, in order to generate more revenues to fill in the huge deficits that the US is running. A similar move by the Canadian government in 2006 to phase-out the Canadian royalty trust structure led to losses in principal and income for investors who were relying exclusively on Canroys. The most important thing is to be diversified and not have over 10-15% of one’s portfolio in master limited partnerships such as Enterprise Product Partners (EPD) or Kinder Morgan Partners (KMP).

Another risk that will be mitigated for this MLP is incentive distribution rights, which allow the general partner a cut of distributions above certain thresholds. This would not be an issue for EPD, since on September 7 it announced plans to purchase the general partner that held those rights, and merge it with one of its wholly-owned subsidiaries. This move would lower the cost of capital for EPD.

The return on assets dropped off sharply between 2000 and 2003, before starting to recover since 2003. Master limited partnerships typically grow by purchasing new assets, which is one reason that this indicator would fluctuate over time. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Overall I find Enterprise Product Partners (EPD) to be an attractive dividend stock for current income and distribution growth. It yields 5.50% and trades at a P/E of 21.40. I would consider initiating a position in the stock on dips below $39.

Full Disclosure: None

Relevant Articles:

- Kinder Morgan Energy Partners (KMP) Dividend Stock Analysis
- Master Limited Partnerships (MLPs) – an island of opportunity for dividend investors
- General vs Limited Partners in MLP's
- MLPs for tax-deferred accounts

Friday, May 29, 2009

MLPs for tax-deferred accounts

Master Limited Partnerships are very good investment vehicles for individuals looking for high current dividend income. There are some tax issues with reporting MLP income in a taxable account, which led me to explore investing in MLPs through an IRA or ROTH IRA account.
In a taxable account, most of the distributions are considered a return of capital, and thus you do not pay taxes on that portion. This tax deferral does decrease your cost basis however, which could mean higher capital gains or ordinary income taxes if you sell. Because of the supposedly complicated tax returns from MLPs, some investors are shunning MLPs as a class althogether. Others are considering simply purchasing those MLPs in a tax advantaged account, and forget about them.

For non-taxable accounts however, there is a gray area from a tax perspective whether or not one could hold MLPs there. The distributions that an individual that holds a master limited partnership in an individual retirement account receives could be considered unrelated business taxable income subject to taxation. As long as the UBTI from all MLPs in an IRA does not exceed $1000 in a given year, your partnership distributions won’t be taxed.

If the UBTI does exceed $1000 however, the custodian that holds your IRA would have to file a form 990T to the IRS. The tax is paid out of the IRA on the net income from your MLP distributions, which are taxed at the corporate rate.

The UBTI has generally been a non-issue for most MLPs over the past few years, but this isn’t guaranteed. Some like Kinder Morgan (KMP) have even had a negative UBTI in some years, which could be offset against any positive UBTI amounts from other MLPs. Kinder Morgan is one of my Best High Yielding Stocks for 2009.

I do believe however that paying a small tax out of your MLP distributions in an IRA shouldn’t be a big hassle, since distributions are rich and taxed at the corporate rate. One should check with their IRA custodian however in order to asses the amount of fees that the IRA has to pay if the UBTI threshold is exceeded.

If you do not feel comfortable putting ordinary master limited partnerships in a tax-deferred account but feel that you might be missing out, there are still workarounds for this situation. There is an easy way to invest in two MLPs without worrying about taxes too much – Kinder Morgan (KMP) and Enbridge Energy Partners (EEP). They pay their distributions directly as additional shares, which is similar to automatic dividend reinvestment. If you choose to invest in KMP or EEP in an IRA, consider investing in KMR and EEQ.

KMR and EEQ are great vehicles for taxable accounts as well since their distributions are not taxable when received, and thus shareholders are not issued an annual 1099 tax form. You would pay taxes only when you sell your units.

The taxation characteristics of your investments are just one part of the investment puzzle. Always make sure to investigate the company’s fundamentals and do your homework before investing in stocks.

Several publicly traded closed end funds such as Tortoise Energy Infrastructure Corporation (TYG), Tortoise Energy Capital (TYY), Tortoise North American Energy Corp. (TYN), and Kayne Anderson MLP Investment Company (KYN) provide a proper diversification within the MLP sector. They are suitable for IRAs since they send out Form 1099-DIV instead of K-1, which also makes it easier for investors with taxable accounts to file their annual tax returns. In most cases the dividends received are treated as a return of capital, which reduces your cost basis. In such cases the distributions are not treated as taxable income. Investors would only have a tax liability when they sell their closed end fund.

These closed end funds also do not generate any unrelated business taxable income (UBTI). The main disadvantage of these closed end funds are their steep annual management fees.

Tortoise Energy Infrastructure Corporation (TYG) has an annual management fee of 0.95% plus a 0.19% charge for other expenses for a total annual expense ratio of 1.14%.Tortoise Energy Capital (TYY) has an annual management fee of 0.95% plus a 0.25% charge for other expenses for a total annual expense ratio of 1.20%.Tortoise North American Energy Corp. (TYN) has an annual management fee of 1.00% plus a 0.71% charge for other expenses for a total annual expense ratio of 1.71%.

Kayne Anderson MLP Investment company (KYN) spots an annual management fee of 2.50% in addition to other fees of 3.40% for a total expense of 5.90%.

Because of high expense ratios, I would think twice before investing in those closed end funds. One thing that is certain in the investment world is that higher fees are not necessarily indicative of superior investment performance. If you cut your costs to the bone, you are much more likely to at least track your index benchmark.

Full Disclosure: Long KMR

Get an updated Trend analysis for KMP and EEP.

Relevant Articles:

- Master Limited Partnerships (MLPs) – an island of stabiliity for dividend investors
- Kinder Morgan Energy Partners (KMP) Dividend Analysis
- Best High Yield Dividend Stocks for 2009
- General vs Limited Partners in MLP's

Wednesday, May 20, 2009

General vs Limited Partners in MLP's

There are two types of partners in a Master Limited Partnership structure, a general partner and limited partners.
The general partner manages the master limited partnership and typically holds a 2% economic interest in it. The general partner also receives a percentage of the profits off the top, before the limited partners get their cut. These so called Incentive Distribution Rights allow the general partners to take a higher proportion of incremental amounts over a certain threshold levels. This provides the general partner with a strong motivation to raise distributions to unitholders, which is appealing to them.
The last tier is typically 50/50, which means that general partners receive 50% of any incremental cash flows above a certain threshold level. This could however increase the cost of equity for the MLP and dilute ownership claim of limited partners.

Limited partners are not involved in the day-to-day management of the MLP, and have limited liability. Once the MLPs reach the highest IRD threshold the distribution growth for Limited Partners slows down, while it increases for general partners.
Some MLP's such as Kinder Morgan (KMP), energy Transfer Partners (ETP) and Oneok Partners (OKS) have already reached the top 50% IDR level. Other MLPs such as Entrerprise Products Partners (EPD) have capped their incentive distribution rights threshold to a maximum of 25%. Check my analysis of Kinder Morgan Partners (KMP).
One way to capture the higher distribution growth potential is to purchase the General Partner Units traded on US exchanges. Not a lot of GPs are traded however. One general partner that has reached the 50% incentive distribution rights threshold is Energy Transfer Equity (ETE), which is the GP for Energy Transfer Partners (ETP).

Another major General Partner, whose units could be bought by ordinary investors is Enterprise GP Holdings (EPE). It owns the general partner and limited partner interests in Enterprise Products Partners L.P. (EPE), TEPPCO Partners, L.P (TPP) and Energy Transfer Equity, L.P (ETE). Check my analysis of Teppco Partners L.P..

Full Disclosure: Long Kinder Morgan Partners

Relevant Articles:

- Master Limited Partnerships (MLPs) – an island of opportunity for dividend investors
- Using DRIPs for faster compounding of dividends
- Best High Yield Dividend Stocks for 2009
- Kinder Morgan Energy Partners (KMP) Dividend Analysis
- TEPPCO Partners (TPP) Dividend Analysis

Wednesday, March 18, 2009

Master Limited Partnerships (MLPs) – an island of stability for dividend investors

Master Limited Partnerships are limited by US Code to only apply to enterprises that engage in certain businesses, mostly pertaining to the use of natural resources, such as petroleum and natural gas extraction and transportation. They combine the tax advantages of a partnership and higher dividend yields with the day to day tradability of common stocks.
MLPs consist of a general partner who manages the operations and limited partners who own the rest of the units for the partnership. Unlike corporations MLPs are not subject to double taxation.
Their stocks are called units, while their dividends are called distributions. The units are very easy to buy and sell, as they trade just like any other stock on NYSE, Nasdaq and AMEX.

MLPs mail individualized K-1 tax forms to each unitholder in late February or early March of each year that specifies the tax treatment of the prior year's payouts. A portion of their payouts can be tax-deferred, and it is subtracted from ones cost basis. When you sell your units, some of the gain that comes from certain deductions such as depreciation expense will be taxed as ordinary income. Because of MLPs specific legal structure, investors should consult with their tax advisor before investing in them.

The majority of Master Limited Partnerships engage in the transportation and storage of natural resources such as refined petroleum products and natural gas.

Thus MLPs typically enjoy toll-road business models. Thus:

- They do not take title to the commodities transported
- Are mostly indifferent to fluctuations in commodity prices because they are paid to transport not produce commodities
- They do not have significant credit risk as commodity prices balloon.
- MLP’s receive a fixed fee for moving a product over a certain distance through their pipelines

Other qualities that enable these stable enterprises to keep increasing their dividends over time include:

-Long Useful Lives of their assets
-Fees are indexed to inflation, which provides an inflation hedge
-Most MLPs have a near monopoly in their area
-There is a high cost of entry and thus there is virtually no competition

There are different types risks to investing in MLPs as well, including Regulatory Risks, Interest Rate Risks and Liability Risks.

MLPs are subject to Regulatory Risks. Currently most partnerships enjoy a pass through taxation of their income to partners, which avoid double taxation of earnings. If the government were to change MLP business structure, unitholders will not be able to enjoy the high yields in the sector for long. In addition to that since the fees that MLP charge for transportation of oil and gas products through their pipelines are regulated by the governments, this could affect the revenue stream negatively.

MLPs also carry some interest rate risks. During increases in the interest rates by the FED in 1994, 1999 and 2004 the partnerships didn’t produce decent returns to shareholders. Because of the ability to grow their cash flow base, MLPs could relatively outperform in a rising interest rate environment.

Liability risk -Unitholders typically have no liability, similar to a corporation's shareholders. Creditors however have the right to seek the return of distributions made to unitholders if the liability in question arose before the distribution was paid. This liability stays attached to the unitholder even after he or she sells the units.

The benchmark for Master Limited Partnerships, the Alerian MLP Index, has enjoyed above average annual total returns of 11.90% from 1995 to 2008. Part of the strong performance could be attributed to the above average distribution yields that most MLPs enjoy, coupled with strong growth in distributions. Master limited partnerships generate predictable and growing cash flows, which are somewhat immune to commodities price volatility and overall economic conditions. Despite the fact that the Alerian MLP Index lost 36.90% in 2008, the index is virtually unchanged so far in 2009.

The five MLPs with highest weights in the index include:

Kinder Morgan Energy Partners (KMP) owns and operates natural gas, gasoline, and other petroleum product pipelines. Also operates coal and other dry-bulk materials terminals and provides CO2 for enhanced oil recovery projects. KMP has managed to increase annual distributions by 13.90% on average since 1993. The partnership’s units currently yield 9.10%. Check out my analysis of Kinder Morgan, which is one of my best high yield stocks to own in 2009.

Enterprise Products Partners (EPD) owns onshore and offshore natural gas, natural gas liquids, crude oil and petrochemical pipelines and associated facilities. EPD has managed to increase annual distributions by 9.60% on average since 1999. The partnership’s units currently yield 9.80%.

Plains All American Pipeline (PAA) owns crude oil and refined products pipelines and associated facilities, primarily in Texas, California, Oklahoma, Louisiana and the Canadian Provinces of Alberta and Saskatchewan. Also involved in the marketing and storage of liquefied petroleum gas. PAA has managed to increase annual distributions by 7.40% on average since 1999. The partnership’s units currently yield 9.30%.

Energy Transfer Partners (ETP) owns natural gas pipelines and associated facilities. ETP also markets propane to retail customers in 40 states. ETP has managed to increase annual distributions by 13.50% on average since 1998. The partnership’s units currently yield 9.90%.
Oneok Partners (OKS) owns natural gas pipelines, processing plants and associated facilities, mostly in the Mid-Continent region. OKS has managed to increase annual distributions by 4.70% on average since 1994. The partnership’s units currently yield 10.20%.

As usual these MLPs are just a starting point for research and should not be taken as recommendations. Because of their unique structure, consult with a tax professional before investing in them.

Full Disclosure: Long KMR

This post appeared on Edition #197 of Carnival of Personal Finance

Relevant Articles:

- Best High Yield Dividend Stocks for 2009
- Kinder Morgan Energy Partners (KMP) Dividend Analysis
- TEPPCO Partners (TPP) Dividend Analysis
- No Risk Stock Market Investing
- Edition #197 of Carnival of Personal Finance

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