7 MLPs to Consider as Oil Prices Climb
These master limited partnerships (MLPs) are benefiting from a rebound in oil prices – and offer an interesting option for yield-starved investors.
Don't look now, but oil prices are starting to rise in a big way. Thanks to increasing demand and restrictive supplies, the energy patch is finally becoming a gusher after several quarters of drifting along. For those in the sector, it's breathed new life into revenues, profits and share prices. And that includes beleaguered master limited partnerships (MLPs).
Truth be told, MLPs were fraught with plenty of issues before COVID-19. Thanks to the Republican tax reform legislation that was passed in 2017, which eliminated the income tax allowance for MLPs, the structure didn't make much sense anymore for corporations to pursue.
Meanwhile, restrictions on ownership from institutional investors removed demand for MLP units. Add in the coronavirus crisis and you had a recipe for disaster. As a result, plenty of lesser MLPs folded up shop, while several others were bought out by their general partners.
However, with oil prices surging, natural gas flowing through pipelines and demand for crude returning, the MLPs that are left offer an interesting portfolio addition for yield-starved investors.
Many top MLPs still remain and have only gotten that much stronger and larger during the downturn. Featuring high tax-advantaged yields, hefty cash flows and a newfound sense of stability, the industry could be a top-draw for investors.
With that, here are six of the best MLPs and one exchange-traded fund (ETF) for those looking for strong return potential, modest risk and higher yields.
Data is as of July 6. Distribution yields are calculated by annualizing the most recent distribution and dividing by the share price. Distributions are similar to dividends, but are treated as tax-deferred returns of capital and require different paperwork come tax time.
Magellan Midstream Partners
- Market value: $10.9 billion
- Distribution yield: 8.4%
There's a very good chance that the gasoline in your car's tank went through a Magellan Midstream Partners (MMP, $48.88) system. Nearly 50% of the nation's total refining capacity – either going in or coming out – can tap into one of MMP's lines, terminals or storage farms. And that fact has arguably made Magellan one of the best MLPs of all time.
The firm operates 11,000+ miles worth of pipelines, terminals or storage facilities with a focus on crude oil and refined petroleum products. There's no natural gas or other energy commodities in its mix. This has allowed Magellan to be a major player in the niche market.
Exploration and production firms book time on its system to get their product to refiners, and refiners use the system to get their products to market. There's really no flimflammery.
The success of Magellan Midstream also comes down to its tried-and-true fee-based business model. MLPs have been called "toll-roads" for the energy industry. Magellan is one of the few that has continued to stick to that mentality and collects checks based on the volume of crude oil through its pipelines. Commodity-price risk is tame with the firm, considering more than 85% of its revenues come from fees. Ancillary services make up most of the rest.
How this plays out for investors is that cash flows at MMP have been robust for the long haul. As an MLP, that cash goes right into the unitholder's pockets.
During the first quarter of 2021, MMP reported distributable cash flow (DCF) of $276.5 million. That gives it a coverage ratio of 1.2x. Coverage ratio is a metric that basically shows how much a firm is earning over its distribution. Magellan is right in the sweet spot for MLPs. That strong coverage ratio allowed MMP to keep its distribution steady at $1.0275 per quarter throughout the pandemic.
With results beginning to improve, management has already hinted that the firm will get back to its distribution increasing ways. Given its conservatism and 8.4% yield, Magellan makes a fine addition to any income portfolio.
- Market value: $30.8 billion
- Distribution yield: 9.2%
One of the hallmarks of being a solid MLP is having a strong partner. That's because partners are able to "drop-down" assets into the MLP and benefit from the distributions paid back. If you have a larger partner with plenty of pipelines and facilities, you can keep this process going for quite a while and build a big base for expansion. That's just what MPLX (MPLX, $29.88) did with its partner Marathon Petroleum (MPC).
MPC originally set up MPLX to hold the pipelines that feed its own refineries and take away refined petroleum products. That segment still produces the lion's share of the firm's earnings – about two-thirds in the latest quarter. The rest comes from its natural gas assets picked up back in 2015, which have been a game changer for MPLX.
With these, the firm owns and operates several natural gas gathering systems that tie into a variety of crackers and processing facilities. These natural gas liquids (NGLs) like ethane and propane have added value and can be processed further into chemicals and plastics.
It's here that MPLX has seen the biggest driver of growth. Tied to commodity prices, these NGLs and cracking facilities have added an incremental boost to MPLX's bottom-line since their addition.
With natural gas and oil prices rising, they are doing it again. Segment adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) for the first quarter of 2021 jumped by $31 million when compared to the same period last year. Marathon cited higher prices and lower operating expenses for the jump.
What gets juicy for investors is that MPLX was already covering its payout. For 2020, the firm's coverage ratio averaged a comfortable 1.5x. With the added boost, Marathon was able to increase its coverage to 1.6x. That suggests its current 9.2% yield is pretty safe – and there's plenty of room for further distribution hikes.
- Market value: $28.8 billion
- Distribution yield: 5.7%
There are MLPs, then there are MLPs. The emphasis comes from the fact that some midstream firms are truly behemoths. Energy Transfer (ET, $10.66) certainly fits into that camp. ET owns and controls more than 90,000 miles worth of pipelines and associated energy infrastructure crisscrossing 38 U.S. states and Canada.
That size and scope has been a feat of engineering in of itself. The firm has grown through a combination of M&A and bolt-on acquisitions. This is even true today. ET is set to swallow-up rival Enable Midstream Partners (ENBL) – a move that will be immediately accretive to its cash flows.
The problem with all of this is ET became an alphabet soup of various MLPs. ET controlled the general partner interests and owned units in limited partners (LPs), even as some of those LPs were still publicly traded. ET itself was at one point divided into two MLPs – Energy Transfer Partners (ETP) and Energy Transfer Equity (ETE). Energy Transfer historically traded at a discount to many of its peers solely because its structure was so complicated.
Since 2018, ET has undergone a major transformation with regards to structure. It absorbed many of its smaller public MLPs into its larger corporate organization, merged ETE and ETP together, and underwent several operational simplification efforts.
Those willing to focus on ET's current leadership position will be well-rewarded. Thanks to its size and scope, Energy Transfer remains a cash flow machine.
By just how much?
During the first quarter of 2021, ET managed to produce an extra $3.5 billion in cash flows after paying its distribution. And with expansion projects and the ENBL acquisition to help boost cash flows further, ET's dividend might be as good as gold.
Enterprise Products Partners
- Market value: $53.5 billion
- Distribution yield: 7.4%
If Energy Transfer is the elephant in the MLP space, then Enterprise Products Partners (EPD, $24.47) would have to be the rhino. EPD is just slightly smaller at around 50,000 miles worth of pipelines covering natural gas, crude oil, refined products and NGLs. It owns a variety of terminals and ports, barges, coal depots … you name it. So, it's far from a small fry when it comes to energy infrastructure.
That massive base has provided EPD with stability over the years with 22 straight years' worth of dividend payments since its initial public offering (IPO). This stability even came during the pandemic, when Energy Product's coverage ratio was a juicy 1.6x. The MLP was able to raise its distribution during the first quarter of this year, as well.
All of that is well and good, but what is exciting for EPD is that it has perhaps seen the writing on the wall. As we transition to a low-carbon future, renewables and other non-fossil fuel energy sources are becoming a more important piece of the energy pie.
To that end, Energy Products has unveiled a new team to look for opportunities in the renewable energy infrastructure space, including solar and wind, carbon capture and hydrogen. And it's not just executive boilerplate. EPD recently purchased a Texas-based 100MW solar project.
In the end, it shows that EPD is forward-thinking.
For investors, it provides an opportunity to bet on today and tomorrow. Crude oil is driving the show these days, while natural gas and renewables are the fuels of the future. Energy Products allows investors to play both sides of the coin, all while collecting a safe 7.5% distribution.
Shell Midstream Partners
- Market value: $5.8 billion
- Distribution yield: 12.3%
Nothing yielding 12% can be considered risk-free, even when it comes to vehicles designed to push a lot of cash flow to investors. This is true for Shell Midstream Partners (SHLX, $14.65). There's some risk here, but also some reward.
SHLX is obviously a spin-off of oil major Royal Dutch Shell (RDS.A). It was designed to own a variety of Shell's midstream and logistics assets that bring crude oil to refineries and refined petroleum products to market.
As mentioned earlier, a strong parent relationship can often bring plenty of lucrative drop-downs into the mix. But in SHLX's case, an overbearing parent can cause a lot of headaches.
For starters, RDS has started to seriously commit to a low-carbon energy plan. That means shedding fossil fuels in non-core areas, including midstream projects. This limits plenty of drop-down growth.
And it's not that SHLX has tons of extra cash lying around ... but RDS wants what it does have. For example, Royal Dutch Shell only recently agreed to eliminate so-called incentive distribution rights (IDRs) – which give the general partner a greater share of profits – from SHLX and was one of the last MLPs to do so. As such, SHLX is paying much of its cash flow as distributions. Coverage ratio for the MLP ended last year at 1.0x and it would have been less if oil company Shell took their IDR payments.
The final factor is that SHLX's share price is low and can't be used as currency to its parent organization to participate in drop-downs. Part of the reason for the low unit price is that SHLX owns a stake in the much-beleaguered Colonial Pipeline.
So, why include SHLX on this list of best MLPs in the first place?
Well, things have already started to turn around in 2021. SHLX's coverage ratio improved to 1.1x in the first quarter, while cash available for distributions increased 4.8% year-over-year. Meanwhile, SHLX has $1.2 billion in liquidity on its balance sheet. In the end, the 12.3% yield is safe, it's just not going to grow very much until Shell Midstream's problems with its parent organization are resolved.
But for investors looking to boost their income today, SHLX is a decent bet.
- Market value: $624.7 million
- Distribution yield: 7.2%
Hop into a time machine and travel back to 2013 and you'll see a bitter battle between integrated energy name Hess (HES) and activist investor Elliott Management. The results of that fight included plenty of asset sales and the formation of an MLP spin-off – Hess Midstream (HESM, $24.95). This is one case where investors may have won.
HESM's main focus is the lucrative Bakken shale field and it operates so-called gathering lines. These are the pipes and trunk lines that hook-up various oil wells from across the field and bring them into a central location. The midstream firm also has assets in terminal and storage and some NGL processing capabilities in the region.
The significance of this focus is that the Bakken is one of the lowest cost and prolific shale regions in the nation. Because of this, energy producers have continued to drill and operate in the Bakken, even with low oil prices and non-existent pandemic demand.
What's even better is that HESM was one of the first firms to build any sort of infrastructure in the region. Before them, energy firms had to use rail cars to ship crude oil out of the Bakken. This has given Hess a sort of monopoly in the region.
And it's been wonderful for HESM's bottom line. Distributions at the MLP remain well covered by cash flows, as evidenced by a 1.4x coverage ratio during the fourth quarter of 2020. This jumped to more than 1.6x in the first quarter of this year. Additionally, the firm boosted its quarterly cash distribution by 5% in the first three months of 2021.
Growth for HESM comes in two ways. First, higher prices are driving hefty drilling activity and that will boost throughput in its system in the Bakken. Second, while Hess Midstream lowered its full-year capex (capital expenditures) budget in fiscal 2021, the $160 million it has committed will be focused on gathering lines and processing capacity in the region. As a result, management expects available distributable cash flows to jump 19% this year at the high end of estimates.
While it may be small and limited in its focus, HESM is a powerful MLP player within its niche.
Alerian MLP ETF
- Assets under management: $5.8 billion
- Distribution yield: 7.8%
- Expenses: 0.90%, or $90 annually for every $10,000 invested
Given the potential in many MLP names to rebound along with rising energy prices and demand, thinking broadly could be one of the better avenues for many investors. ETFs continued to offer one-ticker access to various sectors. And when it comes to MLPs, the Alerian MLP ETF (AMLP, $36.47) is king of them all.
The $5.8 billion AMLP tracks the benchmark Alerian MLP Infrastructure Index. This benchmark is made up of those MLPs that derive their cash flows from the transportation, storage and processing of energy commodities. We're talking just midstream firms. That's key as there are a lot of firms that use the MLP structure to engage in other energy-related activities like coal mining or wood production. AMLP's holdings include everyone on this list minus Hess Midstream.
Now, there is some "funkiness" with AMLP.
Thanks to the Securities and Exchange Commission (SEC), there are restrictions for open-end funds that hold MLPs, so AMLP had to be structured as a C corporation. As a result, AMLP itself is forced to pay corporate taxes. That can create some underperformance versus its benchmark. However, the Republican tax reform of 2018 reduced this factor. Additionally, "bad years" for the ETF can produce tax assets that it can use to offset taxes in "good years." That's been the case in recent years given the struggles within the sector.
Despite the complexity, AMLP has been a good vehicle to add MLP exposure and yield to a portfolio. Two other benefits: There's no nasty K-1 statement come tax time and there's the ability to use the ETF in an IRA.
With an expense ratio of 0.90% and a yield of nearly 8%, AMLP is one option for investors looking broadly at MLPs.