In these early days of 2023, I often find myself thinking about how attractive Master Limited Partnership (MLP) investments look as we move into the year. After a great 2022, energy infrastructure companies are poised to perform well again this year. The big choice is whether to invest in midstream MLPs or shares of midstream corporations.
Here’s what I found – and the best investment to make now…
The terms energy midstream and energy infrastructure are interchangeable. These are the assets and companies that provide gathering, transportation, storage, and terminals between the upstream operations (oil and gas drilling) and downstream operations (refining, chemical manufacturing, utilities).
Before 2015, most midstream companies were structured as MLPs. The prevailing business model involved funding growth projects with a combination of equity and debt. The growth generated growing free cash flow, most of which was paid out as distributions to investors. For at least two decades, MLPs were outstanding dividend growth investments.
The energy sector crashed from 2015 through 2018. The debt-heavy MLP business strategy stopped working. The energy sector crash was a period of massive business restructuring among midstream companies. Companies reduced leverage ratios and cut back on distribution payout levels. They transitioned to paying for growth out of internally generated cash flow.
Additionally, many companies chose to restructure into corporations, leaving the MLP sector behind.
Currently, midstream companies are in excellent shape. Leverage is low, and free cash flow is high and growing. Dividends are well covered, with many companies showing more than two times coverage of the distributions paid to investors. The choice for investors now revolves around whether to focus on midstream companies organized as corporations or as MLPs.
Master limited partnerships often get passed over because they send out Schedule K-1 forms for tax filing. Also, if MLP shares are owned inside a qualified retirement-type account, they can cause tax issues.
Let’s compare the relative valuations of MLPs versus corporations in this sector.
First, three of the larger midstream companies are organized as corporations. I want to look at the current dividend yield and the dividend growth over the last year:
- Kinder Morgan Inc. (KMI): Current yield: 5.9%. Year-over-year dividend growth: 2.78%.
- ONEOK, Inc. (OKE): Current yield: 5.3%. Dividend growth: 0%.
- The Williams Companies (WMB): Current yield: is 5.2%. Dividend growth: 3.66%.
Now let’s look at the three biggest holdings of large-cap, representative MLPs on the Alerian MLP ETF (AMLP).
- Energy Transfer LP (ET): Current yield: 8.4%. Dividend growth: 73.6%. (Yes, 70% year-over-year dividend growth!)
- Enterprise Product Partners LP (EPD): Current yield: 7.7%. Dividend growth: 8.89%.
- Western Midstream Partners LP (WES): Current yield: 7.1%. Dividend growth: 54.8%.
Last year, MLPs kicked in the afterburner for dividend increases. I expect the group to continue with high single-digit annual increases. The numbers above highlight the superior return potential of MLPs.
If you want to stay away from K-1s, investing in MLPs through an ETF like AMLP converts their distributions into 1099 reported income. AMLP tracks the Alerian MLP Index. For an actively managed MLP ETF, I recommend the InfraCap MLP ETF (AMZA).
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This post was originally published on InvestorsAlley