A British prime minister in 1845 described them as those who "bamboozle one party and plunder the other." Since then, common folk everywhere have wanted to eradicate them.
The object of this scorn? Middlemen -- people or companies that buy or handle goods from producers and sell or deliver them to retailers or consumers, exacting a toll for their efforts.
How can producers get better prices? Eliminate the middleman. How can consumers get better prices? Eliminate the middleman.
It seems middlemen just can't get any respect -- that is, except from savvy investors who recognize the profit potential of companies that specialize in brokering goods and services.
Being a middleman can be particularly lucrative in companies that handle commodities -- especially beaten-down commodities whose depressed prices could spur demand down the line.
Take aluminum, for example.
Last year's worst performer in the Dow was aluminum producer Alcoa (NYSE: AA), which fell 43.8% in 2011. And it's not hard to see where most of the pressure came from: Aluminum prices plunged close to 20% during the same period.
Another aluminum vendor that felt the pinch: Aluminum Corp. of China (NYSE: ACH), which was already being squeezed by rising costs for the electricity used in its plants. ACH shares were down 52.6% in 2011.
Yet one aluminum company -- Kaiser Aluminum (Nasdaq: KALU) -- not only held its own last year (down only 8.4%) but has gone on to have a banner 2012. Since the beginning of the year, aluminum producers -- as measured by Global X Aluminum ETF (NYSE: ALUM) -- are up a modest 3.5%. Kaiser, by contrast, has surged 33% this year, nearly 30 percentage points more than the rest of aluminum sector.
Kaiser's secret? It's newfound middleman status.
Scarcity & Real Wealth's Nathan Slaughter attributes Kaiser's performance largely to the company's decision to abandon its "upstream" operations.
What this means is that Kaiser no longer mines bauxite, the primary raw ingredient that is refined into alumina, which in turn is smelted to make aluminum. And that's why Kaiser is no longer vulnerable to weak prices for alumina and aluminum (down another 5.5% this year).
Instead, Kaiser focuses on "downstream" fabricated mill products. As a middleman, the company buys raw aluminum and turns it into something useful, such as the plates, sheets, rods and coils that are used in cars, jets and machinery.
As Nathan puts it, "It's similar to the difference between selling a stack of finished lumber instead of a truckload of pine trees."
And last year's drop in aluminum prices? Think of it as a 20% drop in costs for Kaiser, whose business model is built around "metal price neutrality." This means most of the firm's products are sold under floating rates that can be adjusted up or down to reflect changing conditions in the aluminum market, according to Nathan. In other words, Kaiser's fortunes depend more on the quality of its products than on input costs.
Action to Take --> Kaiser's model isn't the only "middleman" approach that's available to investors either. In the most recent issue of Scarcity & Real Wealth, Nathan recommended another type of intermediary, one that has the added advantage of controlling a significant slice of its market. Not only is this company benefiting from one of the biggest trends in America right now, it has also boosted its dividend for 19 straight quarters.
Here's more from Nathan on this "middleman" approach...
Bob: When it comes to the middleman play, master limited partnerships (MLPs) seem to fit the bill, Kaiser notwithstanding. What is the MLP advantage?
Nathan: MLPs were built for the job. These are the unsung workhorses of the energy sector. ExxonMobil (NYSE: XOM) and other integrated oil companies can bring crude to the surface and refine it to make gasoline and other everyday products. But they can't do it all.
Just as a quarterback needs blockers and receivers to win a football game, energy companies are dependent on silent partners to help gather oil and gas from the field, and ship it across the country. These partners own pipelines, storage hubs and other critical midstream infrastructure -- they don't buy and sell commodities, they just get paid to move them.
About two-thirds of the industry's revenue come from fees. Essentially, these are toll collectors whose profits are tied to the amount of traffic traveling along their highways -- and the roadways are always congested. There is such a lack of takeaway capacity in some new shale plays that natural gas is simply being flared (burned away) because there's no way to get it to market.
That's why new pipeline projects are being built all the time -- and every new conduit means more fee-based income for the owners. Keep in mind, these tax-advantaged businesses are also exempt from federal income taxes, so there is more cash on hand to distribute to investors. That's one reason dividend yields of 5% or higher are the norm.
Nathan: Spectra is one of those workhorses I was just talking about. The company owns 3,200 miles of interstate gas transmission pipelines, enough to stretch from New York to Los Angeles with 500 miles to spare.
Spectra's interstate pipelines form a vital link in the energy chain. The company transports natural gas from rural supply basins to power-hungry customers in big city markets such as Orlando and Tampa. The gas flowing through these lines could be cheap or expensive. It doesn't really matter -- Spectra gets paid handsomely either way.
Bob: What makes Spectra stand out?
Nathan: First, as in real estate, the value of any pipeline depends largely upon location, location, location. Spectra's pipelines are strategically positioned to cash in on the unstoppable transition from coal to natural gas as the nation's chief electricity feedstock.
The company has assets in place from the Gulf Coast to the Appalachians, but the crown jewel is the East Tennessee System, which runs 1,517 miles and serves 179 delivery points in the southeast and Mid-Atlantic states. This pipeline system picks up supplies from dozens of receipt points and distributes it to hundreds of utilities, power generators, and other large industrial customers.
Spectra's cash flows are also more visible than most of its peers. Some companies claim to be fee-based in nature and somewhat immune to volatile commodity price swings. But that might only be for half of their revenue.
By contrast, just 7% of Spectra's revenue is tied to contracts that are variable in nature or subject to interruption. The remaining 93% comes from "capacity reservation fees." This means customers are paying just to reserve access to its pipelines and storage facilities. And the rates are fixed -- customers don't pay more or less if gas prices rise or fall.
Bull market, bear market, sideways market -- the "rent" checks just keep coming in. And here's the best part: These contracts won't expire anytime soon. In fact, they have an average remaining life of 11 years. So customers that have reserved space on the company's gas transportation highway are locked in until 2023.
Bob: That sounds good in theory, but how does that play out on the bottom line?
Nathan: Because most of Spectra's transportation capacity has been booked solid at rates that can't decrease, by customers who can't leave, under contracts that can't be cancelled, the income generated by its rent-earning assets is ultra-secure.
We could talk for days about cash available for distribution and other such metrics, but the dividend track record tells the whole story. Spectra began trading following a spinoff in 2007. And in the five years since, the company has already hiked its distributions 19 straight quarters.
As you can see, despite falling natural gas prices, SEP has still managed to hike its dividend steadily for 19 consecutive quarters. In fact, just one day after an acquisition that will be immediately accretive to earnings next year, management announced plans to raise the payout again -- to 49 cents per unit, for an annual dividend of $1.96.
That's a hefty (and well-supported) 6.5% yield, with more dividend hikes likely on the way.
[Editor's note: A version of this appeared in StreetAuthority Insider, a subscriber-only publication sent to all StreetAuthority newsletter subscribers, free of charge.]