The New York Times today has a piece on Richard Kinder, founder of Kinder Morgan (KMP) the largest publicly traded partnership in the U.S. KMP recently agreed to acquire El Paso Corporation to create an entity controlling 80,000 miles of pipeline crisscrossing the U.S. KMP is a Master Limited Partnership (MLP), which is to say that owners of LP units (as their shares are known) own a proportional stake in the underlying assets rather than shares in a corporation. The big advantage of this structure is that there is no 35% corporate income tax, so the profits flow straight through to the unitholders without the double taxation that occurs when corporations use after tax profits to pay dividends that are themselves taxable. MLPs and KMP in particular also represent an investment in the growth of natural gas as a source of America’s energy production. Cheap shale gas is increasingly being used to produce residential electricity. From 2005-2010 consumption for this purpose grew from 5.9TCFE (Trillion Cubic Feet Equivalent) to 7.4TCFE, more than 70% of the increase in total natural consumption to 24TCFE last year (according to the EIA). A shifting mix of energy sources requires new infrastructure to transport, store and refine it, which is what KMP recognizes. JPMorgan initiated coverage on the sector in October and expects $130BN in infrastructure spending over the next 10 years.
KMP pays a $4.64 distribution, giving a current yield of 5.9%. They’ve grown this distribution at a compound annual rate of 14%. This is high for an MLP, but 6% annual distributions with likely growth of 4-6% over the next 2-3 years is a reasonable assumption, offering the potential for 10-12% total return (assuming multiples are unchanged). Distributions are also largely tax-deferred, since much of the cash received by unitholders is classified on their K-1 as a return of capital, rather than income. Ah yes, you have to deal with a K-1 instead of a 1099. They’re not for everybody, and unless you use a tax accountant and can afford to invest at least $250K in a diversified portfolio of individual names this sector is probably not for you. But for high net worth investors interested in a 6% tax deferred distribution yield with likely 4-6% growth and tolerant of K-1s, this is a sector that belongs in most portfolios. In fact, I think MLPs are a great substitute for high yield bonds. They exhibit similar levels of price volatility (in a weak equity market they can fall farther than you’d like) but offer better return prospects. While unitholders do own equity interests, the overall risk/return characteristics are more bond-like than equity-like.
MLPs are putting in another solid year, with the Alerian MLP Index returning 7.7% for the year through November. That’s ahead of both high-grade bonds (the Dow Jones Corporate Bond Index is +6%) and the S&P 500 (+1.1%) over the same period.
Government policy is to transfer real wealth from savers to borrowers. Policy rates and bond yields are being maintained at levels so low that, after taxes and inflation savers are virtually guaranteed to lose purchasing power. Bonds have their place in a portfolio, and no doubt there are plenty of issues facing markets right now starting with the Eurozone. But given the guaranteed poor long-term outlook for bonds, we think investors should be reducing their overall fixed income weighting in favor of alternative sources of income (such as MLPs) and dividend paying stocks. Retail investors have been steadily increasing their holdings of corporate debt. For example, the iShares iBoxx Investment Grade Corporate Bond Fund (LQD) has seen steady growth in outstandings all year. Corporate bonds have been strong performers for the past couple of years, but with yields on high grade bonds currently around 4%, you can only make 4% and after 2.5% inflation there’s about enough to pay taxes and that’s it. The Federal Reserve is causing this distortion in the fixed income markets. They can keep it up for a long time. Today’s fixed income investors are competing with the world’s deepest pocket – it’s probably time to look elsewhere.
Disclosure: Author is Long KMP
The information provided is for informational purposes only and investors should determine for themselves whether a particular service, security or product is suitable for their investment needs. The information contained herein is not complete, may not be current, is subject to change, and is subject to, and qualified in its entirety by, the more complete disclosures, risk factors and other terms that are contained in the disclosure, prospectus, and offering. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy, completeness or timeliness of this information. Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments. Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.
References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and do not reflect the deduction of the advisor’s fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios managed by SL Advisors as they have different underlying investments and may use different strategies or have different objectives than portfolios managed by SL Advisors (e.g. The Alerian index is a group MLP securities in the oil and gas industries. Portfolios may not include the same investments that are included in the Alerian Index. The S & P Index does not directly relate to investment strategies managed by SL Advisers.)
This site may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involves a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of SL Advisors LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made. r
Certain hyperlinks or referenced websites on the Site, if any, are for your convenience and forward you to third parties’ websites, which generally are recognized by their top level domain name. Any descriptions of, references to, or links to other products, publications or services does not constitute an endorsement, authorization, sponsorship by or affiliation with SL Advisors LLC with respect to any linked site or its sponsor, unless expressly stated by SL Advisors LLC. Any such information, products or sites have not necessarily been reviewed by SL Advisors LLC and are provided or maintained by third parties over whom SL Advisors LLC exercise no control. SL Advisors LLC expressly disclaim any responsibility for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on these third-party sites.
All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.
Past performance of the American Energy Independence Index is not indicative of future returns.