Many MLPs are riskier than you may believe, so careful selection is critical, says Jim Murchie of Energy Income Partners
MLPs invested in such non-cyclical, fee-for-service businesses, however, represent a small minority of the 120-plus energy-related MLPs, says Jim Murchie, founder of Energy Income Partners (EIP).
"What people need to understand is that an MLP is just a structure, a way of financing a business," he
"It doesn't tell you what kind of business it's operating."
Risk-sensitive, income-seeking investors should consider focusing on MLPs that are more impervious to economic ups and downs, Murchie
Blending these in with other high-yielding equities formed as normal, taxable, "C"-corporations will allow such investors "to create a portfolio where the chaos of cyclical businesses is kept outside," he
Just 20 to 30 of the 120 or so MLPs in the marketplace qualify, he
believes--mainly those that own pipelines and related infrastructure.
These MLPs, he
says, are protected from competition and essentially permitted to collect tolls from users to move oil, gas and other commodities in good times and bad.
As for the others, he
dismisses them: "MLPs operating cyclical businesses must either have a low dividend payout ratio, promise only a variable - versus a steady - dividend or someday they will have to cut the dividend."
Investment managers who invest solely in MLPs can get derailed by carrying too much speed through a turn, Murchie
Instead of sticking with steady infrastructure-related businesses, they own MLPs involved in exploration and production or other endeavors that depend on either strong commodity prices or a strong economy.
"Some portfolio managers who are competing with an index think they're doing investors a disservice not to own these high-beta names," he
"I try to get investors to view our strategy as old- fashioned utility investing where you have regulated assets that are not sensitive to the economy," Murchie
"The company puts down $1 billion, and they get a 10%-to- 15% (government allowed) rate of return.
So the charge for the service, whether it's electricity, gas transmission, oil transmission or whatever, is $100 million to $150 million--plus the operating cost.
likes to own these businesses housed by companies that have high dividend-payout ratios (typically 65% to 95% of earnings), because they view a high payout ratio as a sign of capital-spending discipline.
While it may seem as though the allowed rate of return of such companies limits an investor's return potential to the same 10% to 15%.
contends that with the right leadership, companies potentially can ascend along a steeper growth trajectory.
"If a company can find growth opportunities it can fund with either cash or new securities where the returns on invested capital exceed the cash funding costs (that is, the dividends and interest on newly issued equity and debt)," he
says, its shareholder returns can exceed the allowed rate of return on equity.
says the best management teams are the ones who stay out of trouble, avoiding the dumb mistakes that lower returns.
What's more, he
says, "eventually, those management teams will take advantage of somebody else's dumb things [and get] above-average returns for their shareholders."
By investing in the well-run, income-generating businesses that he
says, appropriate investors may be able to capture most of the return potential of a pure MLP portfolio in boom years while avoiding a lot of the downside during in bad years.
Indeed, the success of the energy MLPs since the mid-1990s has been driven by MLPs invested in non-cyclical infrastructure businesses.
The vast majority of MLPs in the 1980s, which were mostly oil and gas producers, were train wrecks when oil prices declined in 1986.
says, the best performing gas and power utilities since the mid-1990s have been those that avoided getting into such cyclical businesses as merchant power generation and energy trading.
Both groups have similar long-term shareholder returns.
It's why EIP
sees itself as a conservative investor in utility-type businesses, Murchie
says, and why it doesn't have "an MLP mandate."