The Perils of Chasing High Yields
The plunge in the shares of one master limited partnership offers an instructive tale.
More money has been lost reaching for yield than at the point of a gun. The truth of this Wall Street aphorism was on display at Boardwalk Pipeline Partners, LP (symbol BWP), a master limited partnership that was yielding nearly 9% before it blew up, with its stock plunging 46% in one day.
The dangers of chasing yield are well worth keeping in mind whether you’re investing in MLPs or in more-traditional stocks and bonds. In a yield-starved world, it’s tempting to buy investments that pay high yields. But high yields never come without high risks.
Boardwalk is an oil and gas pipeline company — a supposedly safer way to invest in energy than buying stocks of regular oil and gas companies. It doesn’t live or die based on changes in the always-volatile prices of oil and gas. Government regulators restrict the number of pipelines, which gives an advantage to existing pipeline owners.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Boardwalk is primarily a toll collector: Oil and gas companies pay to ship their product through Boardwalk’s 14,450 miles of pipelines or to store it in the firm’s underground storage caverns. Most transportation contracts run for years, ensuring relative stability in the firms’ revenues and profits —and investors’ yields.
Organized as publicly traded limited partnerships, most MLPs pay no taxes at the corporate level. That’s part of the reason for their fat distributions, which come in the form of ordinary income and may include the return of capital. The general partner manages the partnership, much like a CEO runs a traditional company. Investors are called unit holders instead of shareholders, and they receive K-1s instead of 1099s.
MLPs have surged in popularity in recent years. In 2000, the MLP universe consisted of just 18 companies with a combined market value of $14 billion, Barron’s reports. The number of MLPs has swollen to 113, with a total market value of $460 billion. The tax code limits MLPs to companies in real estate, natural resources and other commodities.
Boardwalk had among the highest yields of its peers. That excited many investors. It should, of course, have been a red flag.
Before the market opened on February 10, Boardwalk slashed its dividend by 81%, from 53.25 cents a quarter to 10 cents a quarter. The stock, which had closed the previous Friday at $24.09, cratered, closing at $13.01 on February 10. It closed at $12.63 on February 24.
What went wrong? The biggest problem is that Boardwalk’s pipelines are engaged primarily in shipping oil and gas from Texas and the Gulf Coast to the energy-hungry eastern U.S.
The game-changer is the increasing extraction of natural gas and oil from shale, particularly Pennsylvania’s Marcellus Shale formation. The demand for energy from Boardwalk’s pipelines has declined. And you can’t just dig up a pipeline and move it somewhere else.
Oil and gas companies are renewing their contracts with Boardwalk at dramatically lower prices. What’s more, Boardwalk owns natural gas in storage, but due to lack of demand, it doesn’t expect to sell any gas this year. That, in turn, leads to higher maintenance and storage costs. Many pipeline companies buy and sell some oil and gas in addition to shipping it.
Boardwalk can’t change geography, but it could have done a much better job of adapting to changing conditions. Shale is hardly a new story. Other pipeline companies have done much more.
Boardwalk’s high payouts left too little money to reposition the company, says Matt Coffina, editor of the Morningstar Stock investor newsletter. Moreover, he says, Boardwalk borrowed too much money, was poorly managed and did a lousy job of keeping its shareholders up to date.
What should you buy instead? Coffina recommends Enterprise Products Partners (EPD). The yield is only 4.3%, but Enterprise continues to spend heavily on new pipelines, as well as becoming a processor, seller and exporter of natural gas liquids, which have a wide variety of uses, particularly in producing chemicals.
What’s more, unlike Boardwalk, Enterprise isn’t paying out virtually all of its income to investors. Instead, it’s paying out about $1 of every $1.50 in income. That leaves money to reinvest in the business — and to avoid a dividend cut, which, as Boardwalk illustrates, can have such a devastating effect on a stock’s price.
Steve Goldberg is an investment adviser in the Washington, D.C., area.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
-
Should You Change Your Estate Plan Before the Election?
You might need to modify your estate plan before the election — or at least before a new administration.
By Tom Taulli Published
-
When Should Retirees Consider a Donor-Advised Fund?
Charitable giving in retirement isn't right for everybody. But in certain situations, a tax-efficient donor-advised fund (DAF) may be well worth considering.
By Evan T. Beach, CFP®, AWMA® Published
-
Dividends Are in a Rut
Dividends may be going through a rough patch, but income investors should exercise patience.
By Jeffrey R. Kosnett Published
-
Municipal Bonds Stand Firm
If you have the cash to invest, municipal bonds are a worthy alternative to CDs or Treasuries – even as they stare down credit-market Armageddon.
By Jeffrey R. Kosnett Published
-
High Yields From High-Rate Lenders
Investors seeking out high yields can find them in high-rate lenders, non-bank lenders and a few financial REITs.
By Jeffrey R. Kosnett Published
-
Time to Consider Foreign Bonds
In 2023, foreign bonds deserve a place on the fringes of a total-return-oriented fixed-income portfolio.
By Jeffrey R. Kosnett Published
-
How to Find the Best Utility Stocks
When seeking out the best utility stocks, investors should focus on companies with scale and income potential.
By Jeff Reeves Last updated
-
The 5 Safest Vanguard Funds to Own in a Bear Market
recession The safest Vanguard funds can help prepare investors for continued market tumult, but without high fees.
By Kyle Woodley Last updated
-
5 of the Best Preferred Stock ETFs for High and Stable Dividends
ETFs The best preferred stock ETFs allow you to reduce your risk by investing in baskets of preferred stocks.
By Kyle Woodley Last updated
-
The Current I-Bond Rate Until November Is Mildly Attractive. Here's Why.
Investing for Income The current I-bond rate is active until November 2024 and presents an attractive value, if not as attractive as in the recent past.
By David Muhlbaum Last updated