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Investing in Energy MLPs

Brian Hicks

Written By Brian Hicks

Posted August 14, 2014

While Christian is off relaxing on a well-deserved vacation, the rest of us at Energy and Capital are going to delve into one of the most lucrative, high-yielding groups of stocks available in the energy sector: master limited partnerships (MLPs).

More importantly, let’s figure out whether MLPs have a legitimate place in your portfolio. After all, the second biggest energy deal in history just took place…

On Sunday, Kinder Morgan Inc., an operator of over 80,000 miles of U.S. pipeline, announced a complete restructuring of all its assets.

chart 1 kmi pipeline networks

I’m sure those of you already invested in Kinder Morgan or one of its subsidiaries know all about this deal. But for those who don’t, let me give a brief explanation…

Currently, Kinder Morgan is made up of four publicly traded companies: Kinder Morgan, Inc. (NYSE: KMI), Kinder Morgan Management LLC (NYSE: KMR), Kinder Morgan Energy Partners (NYSE: KMP), and El Paso Pipeline Partners (NYSE: EPB).

The latter two are both master limited partnerships, which pay no corporate income tax and pay out 90% of their profits to shareholders in the form of regular dividends.

But after months of investor scrutiny, Kinder Morgan announced it would restructure its four companies under the single incorporated class C corporation.

In order to accomplish this, the company will spend $44 billion in Kinder Morgan stock and cash while assuming another $27 billion in debt.

That brings the deal to a $71 billion value — the second largest energy deal in history. And in case you were wondering, only Exxon’s $74.5 billion purchase of Mobil in 1999 was larger.

More Taxes

But shouldn’t we be questioning the abrupt switch from four companies into one and the abandoning of the master limited partnership altogether?

After all, Hess (NYSE: HES) just restructured its midstream assets into an MLP to avoid the tax penalties, elevating its CEO to billionaire status in the process.

As you might expect, taxes can be a burden on midstream companies, which need substantial capital to expand their pipeline networks.

So why not keep the same structure, or at least reorganize the company into two corporations — one an MLP for the assets and the other a class C corporation for everything else?

Well, Kinder Morgan’s CEO, Richard Kinder, noted that the company gave up most of its profits to investors as dividends, so it became less attractive as it grew during our energy renaissance.

According to him, the deal dramatically simplifies things for Kinder Morgan and will enhance shareholder value going forward.

In fact, the new company is expecting to raise its dividend 16% in 2015 followed by 10% per year for the next decade.

Not too shabby if the plan goes off without a hitch…

In the meantime, however, it seems like investors will lose out come December when the deal goes through.

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Although the market rewarded Kinder Morgan’s various spin-offs, the question is whether the company can maintain this momentum.

chart 2 mlps

Then again, the new company will be a behemoth, with the consolidated enterprise worth approximately $140 billion.

Should You Abandon the MLP?

Of course, the fact that Kinder Morgan — one of the first companies to spin off an MLP — is now getting rid of its MLPs means the talking heads in the mainstream media will be quick to say MLPs are going to die out.

Personally, I’m not buying it… and neither should you.

Last year alone, 19 new master limited partnerships debuted on the market, bringing the total worth of all MLPs to $570 billion.

You can bet those other companies aren’t giving up.

Canadian pipeline operator Enbridge (NYSE: ENB) announced it wouldn’t follow a similar path — it’s maintaining its MLP subsidiary as a separate publicly traded company.

So even though the pundits are heralding an end to the MLP era, the Kinder deal won’t kick-start a new trend, and perhaps it ultimately boosts the value of other master limited partnerships.

Still, there’s a much better way for us to book oil profits.

Although the best gains on El Paso Pipeline Partners, Kinder Morgan Partners, and Kinder Morgan Energy Partners are long gone, let’s not forget the other 115 MLPs — many of them with yields over 10%.

Any investor worth his salt would be foolish to pass up the chance for steady, long-term gains from America’s oil and gas boom.

But if you already have a decent set of long-term income plays and are looking to build a more active position in the energy sector, look no further than the Eagle Ford.

Until next time,

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Alex Martinelli

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