My friend's grandfather dabbled in real estate and land speculation nearly his entire life. He left a substantial amount of farmland to his heirs, but this land never appreciated much, wasn't great for farming and didn't produce any income.
It turns out the land sits atop the lucrative Marcellus Shale formation. The company wanted to lease fracking rights on the land and pay the owners a percentage of the profits from the oil and gas below. The once-worthless land quickly became a moneymaking machine.
If the old land speculator is watching from heaven, he's probably jumping for joy at how his investment turned out. However, you don't have to be a lucky land speculator to profit from the fracking boom.
A master limited partnership, or MLP, is a publicly traded limited partnership that generally operates in the natural resources, financial services or real estate sectors.
One advantage that MLPs have over corporations is that an MLP is considered to be an aggregate of its partners and not a separate entity. This provides the tax advantage of a partnership and the liquidity of an exchange-traded stock.
Midstream MLPs are companies that gather, store and transport natural gas, crude oil and natural gas liquids. In other words, these companies move and store natural resources along the supply chain, from drilling sites to end users. These companies operate with long-term contracts, are often protected by government-regulated rates, and have inflation addressed within the contract. This creates a secure, long-term, dividend-paying investment.
In her research report, Carla likens midstream MLPs to toll-road operators in that they are more dependent on shipping volumes than on the commodity product price itself. Considering that demand for gas and oil is mostly inelastic (meaning demand stays relatively constant, regardless of price), this creates a very secure investment opportunity.
In addition, natural gas and oil production is booming in the United States, with the Eagle Ford in South Texas and the Marcellus Shale in Pennsylvania particularly hot markets. U.S. oil production has increased by 30% since 2009, to more than 6.4 million barrels per day. Natural gas production is also increasing, and interestingly, natural gas prices are trending higher as the supply glut works itself out.
Income investors are benefiting from the success of MLPs. For example, over the past five years, Kinder Morgan (NYSE: KMI) increased distributions by an annual average of 7%; Magellan (NYSE: MMP) averaged 8%, and ONEOK (NYSE: OKS) averaged 6%.
What's the best MLP for investors? I agree with Carla in identifying Kinder Morgan Energy Partners (NYSE: KMP) as a favorite choice to capture profits from the booming MLP business. KMP is the largest midstream company in North America, with 73,000 miles of pipelines and 180 storage terminals.
KMP pays out an annual $5.16 a share in dividends, marking a yield of 5.7% with quarterly payments. Earnings increased from $1.26 billion in 2011 to $1.34 billion in 2012, while fixed assets soared 22%, to $19 billion. Revenue is projected to increase to just over $10 billion in 2013, representing a 17% increase over 2012, as profits from the January acquisition of Copano Energy (Nasdaq: CPNO) begin to flow.
Risks to Consider: It's important to note that KMP has been trading at a premium valuation. A correction in the sector may result in a steep price decline. In addition, alternative fuel sources may eventually supersede the need for traditional commodity fuel products. A slowdown in the U.S. economy could also negatively affect the MLP midstream sector.
Action to Take --> I like KMP for its steady, increasing dividend and appreciation potential and the growth in its underlying business. Given the projections and overall boom nature of the sector, I would not be surprised to see this stock at $115 within the next 18 months. As always, be sure to use stops orders and position size properly when investing.