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Upstream MLPs: The New
Canadian Trusts |
Published:
August 16,
2007
Imagine if you had piled into Canadian income
trusts four years ago -- back when oil prices were still around $25
a barrel. Today, crude sits at closer to $75 per barrel, and the
shares of many oil-related trusts have skyrocketed.
Well, it may be too late to ride many of these trusts to the top,
but it's not too late for another group of energy-related securities
that are bursting out of the starting gate. Six of them have debuted
in the past 20 months, and at least half a dozen more are getting
ready to launch over the next few months.
These are not the highest yielding securities in the income
universe, but their share prices have soared and total returns
(including share price gains and dividends) have been stellar. They
offer an average yield of almost 5%, about as much as a risk-free
Treasury. But when you include share price gains, this group has
delivered investors astounding average annualized returns of +121%.
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What we're talking about are "upstream"
master limited
partnerships (MLPs). These latest MLPs
put a new spin on an old asset class.
Like trusts, MLPs are exempt from income taxes, as long as that
income is distributed to shareholders. This tax-advantaged status
allows MLPs to base their distributions on pre-tax income -- which
makes for far richer payouts than the after-tax income that most
taxable corporations distribute.
The typical MLP owns so-called "downstream" oil and gas assets, such
as pipelines and processing facilities. Pipeline operators Magellan
Midstream Partners (NYSE: MMP), Enterprise Products (NYSE: EPD), and
NuStar Energy (NYSE: NS), are your old-style MLPs.
By contrast, "upstream" assets like oil and gas producing properties
have been stowed away into income trusts. BP (NYSE: BP), for
instance, spun off its interests in the Prudhoe Bay oil field into
BP Prudhoe Bay Royalty Trust (NYSE: BPT) over a decade ago.
But there's a problem with trusts. Unlike MLPs, U.S. energy trusts
aren't legally allowed to expand from their original asset base.
Once BPT's reserves are used up, the trust will fold. Canadian
income trusts like Provident (NYSE: PVX) didn't have that problem.
They enjoyed tax-advantaged income and also had unlimited growth
potential -- until the Canadian government hatched a plan to
eliminate all of them by 2011.
Enter the latest MLPs. They are the new Canadian royalty trusts.
Since they don't pay taxes, so long as they distribute most of their
income, it means they can make generous pre-tax distributions to
shareholders, including the parent company -- which can be a major
shareholder. Plus, MLPs are legally allowed to keep growing through
acquisitions.
About 25 years ago, oil companies like Apache (NYSE: APA) were
rolling their upstream oil and gas assets into MLPs. Then oil prices
plunged, management was forced to slash distributions, and the MLPs
converted back into ordinary tax-paying corporations. The income
trust came to replace MLPs as a more secure investment vehicle for
volatile upstream producing assets.
Now things have come full-circle. Oil prices are once again at
record levels and yield-hungry investors are willing to bet on a
volatile sector in return for high potential rewards. Quick to
respond to this new environment, oil companies are folding their
producing oil and gas properties into upstream MLPs.
And investors can't get enough of this new breed of MLP. Large
institutional investors are piling in, and the MLPs are leveraging
their higher share prices to purchase more assets. That, in turn,
generates more cash flow -- which translates to higher dividend
payouts -- which leads to a higher share price -- which allows the
firm to raise more money to make more acquisitions -- and repeat the
cycle.
Take Constellation Energy Partners (NYSE: CEP), a limited
partnership spun off last November by electric utility Constellation
Energy (NYSE: CEG). The partnership helped fund a $115 million
acquisition by raising $60 million in a share offering. The purchase
gave an immediate boost to the bottom line, which in turn triggered
a +219% hike to the quarterly dividend. CEP shares responded by
climbing +3% the day after the dividend announcement, paving the way
for further acquisitions down the road.
Will the good times keep rolling for these MLPs? The answer depends on several
unknowns, such as where energy prices are heading or possible
regulatory changes that might be in the works. But for now, the
future for the upstream MLPs listed below looks promising.
Important Note: Throughout the
remainder of this article, Editor Carla Pasternak and our research
staff provide the names of six upstream MLPs that have returned
average annualized gains of +121%. However, in order to view
the remainder of this article, you'll need to subscribe to our
premium income-investing newsletter -- High-Yield Investing. After you subscribe
you'll receive immediate access to this full article, as well as
our monthly High-Yield Investing newsletter and a host of
additional premium content. Please visit one of the following links to
continue...
Good Investing!
Carla Pasternak
Editor
High-Yield Investing
http://www.StreetAuthority.com
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Carla
Pasternak draws on a variety of financial backgrounds to make profitable
calls on income-generating stocks for her readers.
Carla has
been employed in the investment industry for more than two decades. In
addition to her work as a writer for several other nationally recognized
financial publishers, her previous experience includes a position as
President of a well-respected investor relations firm. She has also been
writing shareholder reports for public companies (annual reports,
speeches, corporate profiles, slide shows, etc.) since 1980.
A highly
successful investment analyst, Carla specializes in high-yield,
income-paying stocks. In that pursuit, she's always mindful to select
companies that not only pay rich dividends, but that also have the
potential to deliver strong long-term capital gains.
On the
educational front, Carla holds both MBA and Ph.D. degrees. When she's
not watching the market, she's teaching business courses at the college
level and managing several million dollars in portfolio assets.
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