Master Limited Partnerships (MLPs)

One overlooked corner of high income paying investments is in the once rarified air of master limited partnerships (MLPs).

These are limited partnerships that are publicly traded on the security exchanges. They combine the tax benefits of a limited partnership with the liquidity of publicly traded securities.

And these babies are only taxed once at the corporate level leaving plenty of cash to pay back in the form of dividends to its shareholders.

Master Limited Partnerships (MLPs)

Never heard of an MLP? That’s not unusual. They don’t show up on the radar screen of most individual investors.

From the outside, they look complicated. They don’t get played up by the talking heads on TV. And, they suffered a big reputation hit in the 80’s and 90’s when many MLPs were involved in a number of investment scams. Secret deals. Serious debt problems. A few big partners got left holding the bag.

MLPs were once only the investment playground for the rich and big institutions. All of that’s changed now.

Today, MLPs have been cleaned up and have gone main stream. Most of them are traded on the New York Stock Exchange.


You can purchase shares directly from your broker. Ownership is in the form of units as opposed to shares which in effect makes you a limited partner.

MLPs are limited partnerships whose interests (limited partner units) are traded on public exchange just like corporate stock (shares). MLPs consist of a general partner (GP) and limited partners (LPs).

Why Do I Like Master Limited Partnerships?

First, they pay a nice high yield. Usually 7% to 9% and most pay dividends on a quarterly basis. MLPs earnings are taxed only once, at the unit-holder level. By contrast, the earnings of most publicly traded corporations are taxed twice, once at the corporate level and once again at the shareholder level.

As a result, the MLP can pay out significantly more of its cash flow to you, the unit-holder.

Second, a number of MLPs are increasing their dividends. That’s because many MLPs are in mature, asset-rich businesses that generate large amounts of cash flow.

Third, they are relatively safe investments. Most MLPS are energy exploration and production companies, natural gas liquids businesses and pipelines. These businesses are not affected by the rise or fall of oil prices, and their rates are set by regulatory agencies, keeping them predictable and stable.

And fourth, unit-holders, in turn, enjoy real tax deferment. You get enhanced distributions of cash because of the tax shelter provided by the pass-through of the non-cash expenses, at a time when tax shelters are particularly hard to find. This means you will not pay taxes until it’s time to sell the MLP . . . perhaps in retirement when you are in a lower tax bracket.

This tax deferment can be a big plus for investors. While the explanation behind the deferment is too complicated to go into in this article, it’s worth noting that you will receive a separate IRS form from the partnership outlining the tax deferments making it easy for you or your tax adviser include it on your returns.

That’s why MLPs are good long-term investments. You’re not going to want to trade in and out of these companies.

What Do I Look For in an MLP?

First, I look for a MLP that’s paying a big distribution.
Most of the MLPs that I follow all pay out between 6% and 10% annually. Take Dorechester Minerals LP (DMLP) for one, which paid 8.70% this past year and is looking at a 9% plus forward looking dividend.

I look at the financial strength of the partnership. In particular, I keep an eye out for debt. Any partnership carrying a debt-to-capital ratio below 60% is a safe play by me. Another company I follow, Energy Transfer Partners LP (ETP) carries less than a 50% debt-to-capital ratio while paying a growing dividend of 7.5%.

I also look for companies with good management.
Terra Nitrogen Co. LP (TNH) fits that profile. A company engaged in the business of manufacturing fertilizer, has a solid management team and a good long term growth record. TNH has doubled its stock price over the last year while paying out a nice 7.6% dividend.

And finally, I like to go with companies that are in the safe and mature businesses, less exposed to the wild swings in commodities. Pipeline companies are a good example of a relatively safe bet because their prices are regulated. A good name is Valero LP (VLI), a company involved in the energy production and pipeline business with a great track record, and it pays a decent 6% dividend.

MLPs—High Dividend Payments and Steady Price Appreciation

Like any equity, there are risks to MLPs including lack of capitalization, changing regulatory environment and any kind of major economic downturn.

Their prices could turn down if interest rates rise too rapidly. But unlike bonds, MLP prices are regulated, giving them a softer landing and slow rate of change.

So if you’re looking for an investment with reasonable price appreciation while getting paid a nice dividend and with less volatility than the average large cap stock, then consider Master Limited Partnerships.

Combine that with the ability to defer tax payments, MLPs look like one investment that should be in everyone’s portfolio.

- Excerpt from Bryan Perry's blog.