Why This High-Yielding MLP Belongs in Your Portfolio
In today's low interest rate environment, investors are searching for yield. One place they've found it is in master limited partnerships, or MLPs. These tax-advantaged companies are the most popular they've been in recent memory, with several nearing 52-week highs. Despite this, the case for investing in high-quality, well-capitalized MLPs remains strong.
Why you should consider MLPs
The case for investing in MLPs is two-fold. Firstly, these companies are not taxed at the entity level and are required to pass through the majority of their income to shareholders, or unitholders, as they're called in this case.
With the average MLP yielding a little above 6%, the sector offers significantly higher yields than comparable investment vehicles, such as REITs or royalty trusts. But unlike REITs and royalty trusts, MLPs are operating businesses with solid prospects for growing their distributions over time.
Secondly, since most MLPs operate in the midstream energy space, they benefit from the secular oil and gas infrastructure build-out theme. As most energy investors are probably aware, we have a massive glut of natural gas in the country, driven by a rapid and sustained increase in production through major advances in drilling technologies. Similarly, U.S. oil production is at levels unseen since 1998.
Unfortunately, our domestic infrastructure hasn't been able to keep up with the increased production levels -- much of that oil and gas simply accumulates as inventory in regional hubs. To relieve this glut, many midstream MLPs are massively ramping up their spending programs and increasing their asset footprints across North America. One such MLP that I particularly like is Plains All American (NYS: PAA) . Let's take a look at what this pipeline purveyor has got up its sleeve.
A track record of solid performance
Plains All American is the fourth-largest MLP by market capitalization in the country, just behind Enterprise Products Partners (NYS: EPD) , Kinder Morgan Energy Partners (NYS: KMP) , and Williams Partners (NYS: WPZ) . The Houston-based company boasts around $17.8 billion in total assets and has an enterprise value of $19.9 billion. It operates nearly 19,000 miles of pipeline and offers a juicy 4.7% yield.
Plains, like many other midstream MLPs, has been a top performer over the past decade. Since 2002, shares have appreciated nearly 300%, and the company's year-to-date performance of more than 20% easily trounces that of the benchmark Alerian MLP Index, which has gained just a little over 3% this year.
Since 2001, adjusted EBITDA has grown at an annual average of 27%, while distributions have grown at a CAGR of 7.5%. As MLP investors can readily attest, a track record of solid distribution growth is often a telling feature of a company's future distribution increases.
In this respect, Plains has delivered time and time again. Its distributions have increased in 31 of the last 33 quarters and have grown by an annual average of 7.5% over the past decade. Going forward, the company is projecting 8%-9% annual distribution growth, which it expects can be maintained at a healthy 1.3 times distribution coverage ratio.
More growth in the pipeline
One crucial advantage that Plains has over some of its competitors is its relatively high exposure to oil, currently the most profitable of all the commodities transported by the midstream sector. In just the past three years, the oil-directed rig count has risen by around 400%, with some 1,400 rigs currently drilling for oil. In fact, more than 1,000 of those 1,400 oil-directed rigs operate in locations where Plains maintains a major presence.
Clearly, the company's pipeline assets are in an excellent position to benefit from the many lucrative energy plays across the country, such as the Bakken, the Permian Basin, and the Eagle Ford, where oil and gas companies continue to ramp up production. Indeed, Plains' capital spending is largely geared toward serving these high-growth locations.
The company has a massive number of projects slated to come online within the next few years. It expects to spend around $1.15 billion on such projects in 2012, between $800 million to more than $1 billion in 2013, and a baseline of $500 million to more than $700 million in 2014 and 2015. The benefits of this capital spending will accrue over several years and provide a high degree of cash flow stability, which bodes well for further distribution increases.
Finally, it's important to stress the remarkable stability and security afforded by Plains All American's business model. Benefiting from a "toll-road" type of business model, the company enjoys highly predictable income generated from its long-term contracts. As such, its exposure to commodity prices is quite limited. Indeed, this is a defining feature of midstream MLPs.
For instance, peers such as Enterprise Products Partners, Kinder Morgan Energy Partners, and ONEOK Partners (NYS: OKS) also derive the bulk of their revenues from fee-based contracted assets. In the case of Plains, around 70% of the company's baseline EBITDA is derived from fee-based assets.
All in all, I continue to view Plains All American as a solid, must-own MLP, especially for income investors. The company has a strong record of operational outperformance and has held up remarkably well even during highly volatile periods like we saw back in 2007-2009, illustrating the resiliency of midstream MLPs in general.
With a geographically diverse asset base serving some of the fastest growing resource plays in the country, the company is well positioned to take advantage of the continued growth in domestic energy production. It also sports a solid balance sheet with ample liquidity, as well as a healthy distribution coverage ratio. And its 4.7% yield looks easily sustainable and is on track to grow at a rate of 8%-9% for the year.
MLPs like Plains All American play a necessary role in our booming domestic energy market, but they're not the only game in town. Energy services and equipment companies are a crucial part of the picture, as well. In fact, one oil and gas equipment provider is the top pick this year among our analysts here at the Fool. You can read more about this company and why it's ready to soar in The Motley Fool's special free report: "The Only Energy Stock You'll Ever Need." Don't miss out on this limited-time opportunity to discover the name of this company. Click here to access your report -- it's totally free.
The article Why This High-Yielding MLP Belongs in Your Portfolio originally appeared on Fool.com.Fool contributor Arjun Sreekumar does not own shares of any companies listed above. Motley Fool newsletter services have recommended buying shares of Oneok Partners and Enterprise Products Partners. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.