After a painful run since summer, an overlooked corner of the market is rallying, offering both growth and fat yields
Don’t look now, but there’s a sector of the market that’s quietly offering investors 10% yields, and if history repeats itself, 15% – 20%+ price gains …
Today, we’re going to find out where this opportunity lies with the help of InvestorPlace’s income expert, Neil George. For our money, no one knows how to dig up quality, high-yielding investments that don’t require excessive risk better than Neil.
Best of all, he’s generous enough to share one of his specific, favorite ways to play this opportunity.
Lots to cover, so let’s jump in.
***Big upside potential, and fat income distributions while you wait
Today’s opportunity lies in the MLP sector.
For any readers less familiar, “MLP” stands for Master Limited Partnership. To be fair, MLPs are less of a “sector” and more of a tax-advantaged form of financing that wraps around some underlying businesses.
In this case, that underlying business is energy transportation — specifically, the pipelines that transport crude oil from the producers all the way down to the distributors. These are some of the most valuable, strategically significant assets in the United States.
You’ve heard how the shale boom has resulted in the U.S. becoming the world’s leading oil producer?
Well, these are the pipelines that move all that oil from place to place. They’re literally the veins of the sprawling U.S. energy complex.
Now, some quick context to make sure we’re all on the same page …
Traditionally, MLPs have been viewed an income investment, offering investors huge yields. Often these yields run in the 7%-9% range.
MLPs are able to pay these fat yields because they have a different tax-treatment — they pay no corporate tax, but in return, they must pay out a large percentage of their income to unit holders.
So, historically, yield-hungry investors have turned to MLPs for income.
But, today, we’re looking at the potential for both income and a substantial price pop.
***The MLP pain-train since the summertime gives us a new opportunity today
“Midstream” MLPs refer to the MLPs that process, transport, and store oil. There are also “upstream” and “downstream” MLPs. This distinction is important because midstream MLPs are less tied to the actual price of oil.
This is because most midstream firms just transport the commodity, so they get paid based on the volume of oil transported, not based on oil’s price. You might think of it like a toll road, with the rates locked in by long-term contracts.
This gives MLPs some insulation from oil prices, but not complete insulation. What that means is MLPs can be a volatile investment as oil’s price bounces around.
An easy way to see this volatility is by looking at the ETF “AMLP” which tracks the Alerian MLP Index. It includes some of the biggest midstream pipeline companies in the U.S., such as Enterprise Products Partners, Plains All American, and Magellan.
Below is AMLP’s performance history over the last three years. Note the sudden reversals that lead to significant gains … and losses.
Now, let’s get more granular. The MLP sector’s latest pain cycle began this past summer.
From early July through early December, ALMP lost nearly 21%, as you can see below …
I asked Neil what was behind this selloff.
The fall in crude oil prices in the U.S. from April through June led to a drop in rig count.
This led to concerns that oil and gas production would be at risk, placing pipelines in jeopardy for counterparty risk of producers not fulfilling pipe contracts.
Troubles, particularly in natural gas producers, including bankruptcies and potential bankruptcies, further contributed to the risk being assessed on the whole segment.
So, behind much of the selling was broad-based fear that didn’t discriminate between quality MLPs and lesser MLPs.
But we can thank this fear for providing us the opportunity today.
***Has the MLP sector just started a new, sustained rally?
When AMLP rallies, it can rally hard. To illustrate, let’s look at the last 12 months.
The last time AMLP traded as low as it did the first week of December was actually December of 2018, as you can see below.
And as you can see by looking at last year, when its price turned north, the gains came fast.
Below you can see AMLP climbing over 25% from late December through its summer high.
Now, returning to today, what’s been happening in the space recently?
Beginning the first week of December, AMLP began to push higher … fast.
As you can see below, AMLP popped over 7% in less than two weeks. As I write Monday morning, it’s pushing higher, up nearly 8% over this period.
Is this the beginning of a new, sustained rally for the sector?
Neil’s response:
The recent recovery is coming as the good MLPs which I highlight in the Profitable Investing Portfolio are not in, nor were in jeopardy.
And with a lot of value in these companies including the dividend yield — buyers are coming back. Plus, consolidation and private equity is also stepping into the segment.
So, it appears this rally is more so a return to appropriate valuations as investors realize this summer’s selloff wasn’t appropriate for all MLPs.
***Let’s switch gears now, focusing on the traditional reason for owning MLPs — income
As I write, the Alerian MLP Index (AMZ) yields a whopping 10.19%.
This crushes the average yields of competing income investment sectors. See for yourself …
Many individual MLPs within the index yield even more. Note the far-right column below …
So not only is a quality MLP poised to provide double-digit price gains, it’s also paying huge yields as you wait.
***So, what’s the best way to play this?
You could go with AMLP, which is the ETF which tracks the Alerian Index. But if you’re looking for a specific MLP, Neil has an idea for you …
One of my favorites in the gas and oil pipes continues to be Enterprise Product Partners (EPD). The stock is up 9.26% in price since November 19.
Neil goes on to tell us that EPD has just announced it’s working with Enbridge Inc (ENB) to develop a deep-water oil export terminal in the Gulf of Mexico. This should give the company the ability to further raise its revenues and generate profits.
The stock has returned 18.88% year to date, but Neil sees more value here:
Revenues are already up on a trailing year basis by 24.90%. And it is very efficient in its operations with operating margins running at 13.50%. This is returning 20.10% on shareholder’s equity and an impressive 8.00% return on the overall capital of the company.
It runs a good cash hoard, and has limited debts running at 46.20% of assets putting the company above the credit profile of some of its lesser peers around the U.S. market.
Unit distributions are running at 44.25 cents per share for a current yield of 6.44%. And the distributions continue to rise with an average annual increase over the past five years running at 4.18%. And compiled estimates for the next distribution going ex-dividend in January shows a further increase.
Enterprise isn’t Neil’s only MLP recommendation.
He also likes a second MLP, this one offering an 8.26% yield. Not only that, but shares are priced at a 90% discount to sales.
Stepping back, there are some great opportunities in the sector, but investors still need to be careful as some MLPs aren’t as well-equipped to handle counterparty risks.
To read more about which MLPs are safer for your investment dollars, as well as to read more about Neil’s second MLP recommendation, click here to sign up for his Profitable Investing newsletter.
But whether you get Neil’s help or investigate the space on your own, give it a look — low valuations, high yields, and the recent rally are making quality MLPs look mighty good.
