3 High-Yield Investments Worth Considering

The collapse of oil prices in 2014-15 has caused many energy master limited partnerships (MLPs) to cut their distributions, and some of them may even become insolvent.

Nevertheless, not all energy MLPs are invested in oil production, and many in other sectors of the energy space still have reliable payouts.

Apart from the risky but enjoyable refinery MLPs, many energy MLPs can provide reliable income – as long as their business models are solid and they’re not dependent on energy prices or on sources that may dry up.

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MLPs have the great advantage of paying no corporate tax, provided at least 90% of net income is distributed to shareholders.

In practice, many MLPs go well beyond this limit, paying distributions out of cash flow or even borrowing to pay distributions when cash flow is inadequate.

That makes them dangerous investments, especially when cash flow can change sharply as a result of, say, declining oil prices.

My colleague Alan Gula recently wrote a column about these dangers and the “dividend death watch.”

At the same time, the high yields attract income-seeking investors, whose investments can then be used to finance more acquisitions and pay even higher distributions.

But eventually it all goes wrong, as happened to Linn Energy LLC (LINE) in 2015. LINE had to stop paying distributions, and its stock then lost 95% of its value.

It took some time for the drop in oil prices to be reflected in quarterly earnings – and many companies had hedged their sales, thus disguising collapses in operating results through spurious derivatives profits.

But eventually, oil’s collapse caught up.

Pipe Down

Today, the main danger isn’t from producing companies whose earnings collapse, but from transportation and logistics companies that may run out of product.

Companies set up to service the massive “fracking” boom in domestic oil output that has occurred since 2010 likely did fine in 2015, as fracking investments made in 2013 and 2014 continued to produce at full blast.

However, fracking oil deposits have a very short life – typically 18 to 24 months – so those projects will start to run out in 2016. And with oil at $40 per barrel, they won’t be replaced. The price isn’t sufficient to justify the capital required.

Thus, pipelines and infrastructure transporting oil from the Marcellus and other oil shales will have difficulty finding products that can be serviced profitably.

MLPs Worth Considering

Nevertheless, there are still a number of MLPs with high yields and cash flow that should cover payouts going forward.

Bear in mind that you should expect a higher yield on these companies than on a bond or a conventional company’s distributions, because pipelines and other energy service equipment assets have a finite life. Think of the stock as a 20- to 40-year annuity without assurance of full principal repayment at maturity.

With that in mind, here are three worth considering.

  • Enterprise Products Partners LP (EPD) is a large energy midstream company ($50 billion market cap) with operations in natural gas, liquefied petroleum gas, and onshore and offshore pipelines and transportation.EPD offers a 6.2% yield to conservative investors. However, like most energy MLPs, its $0.385 per quarter distribution exceeds its net income of $1.26 in the last four quarters.

    On the other hand, in the first three quarters of 2015 (all during the period of lower oil prices) its payouts totaled $2.22 billion, compared with operating cash flow of $2.59 billion. Thus, there’s a reasonable margin for hiccups.

  • NuStar Energy LP (NS) is at the extreme end of risk and yield that you should consider (there are, bear in mind, lots of companies whose risk is such that you should not consider them).NuStar operates in the areas of pipelines, storage, and marketing of petroleum products and anhydrous ammonia in the U.S., Canada, Mexico, the Caribbean, and Europe.

    It offers a truly juicy yield of 11.7%, based on a quarterly distribution of $1.095.

    Its distributions in the last four quarters totaled $4.38 per share compared with earnings of $3.23 per share – but in the first three quarters of 2015 its payments totaled $294 million compared with operating cash flow of $375 million.

  • Finally there’s TC Pipelines LP (TCP), a Houston-based subsidiary of the giant TransCanada pipelines group. TCP is primarily a natural gas pipeline company, owning interests in six pipeline systems in the western and midwestern United States.It offers a yield of 7.4% based on a current distribution of $0.89. Like EPD but unlike NS, its distribution has been increased regularly by modest amounts.

    Again, its payout of $3.56 exceed its last four quarters’ earnings of $3.00, but the last three quarters’ cost of $178 million was well below operating cash flow of $229 million.

Good investing,

Martin Hutchinson

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Source: Wall Street Daily