Looking For An Income Partner?

9/8/2014


Master limited partnership (MLPs) and other types of publicly traded partnerships are best known for their high yields, in most cases made possible by a lack of corporate taxation. If MLPs generate 90% of their income from "qualifying sources" — most of which involve natural resources, commodities, or real estate — they pay no corporate income taxes.

In the last few years, the Internal Revenue Service has become more lenient in its interpretation of what constitutes natural resources, opening up MLP status to companies that provide services needed to support energy exploration and production, as well firms that make, transport, or store alternative fuels and some industrial gases.

Almost 70 MLPs filed initial public offerings over the last five years, roughly doubling their numbers; our Quadrix universe contains more than 120 publicly traded partnerships. However, the MLP spigot closed in April when the IRS temporarily suspended the approval process to conduct a review of recent rulings, reportedly to assess whether it had become too generous in granting MLP status. A similar review of REIT qualifications in 2013 resulted in little change.

Different types of partnerships

Publicly traded partnerships come in three main flavors — general partners (GPs), limited partners (LPs), and limited liability companies (LLCs). Most publicly traded partnerships offer a stake in the limited partner, with only a few pure-play general partners publicly traded.

GPs generally own a minority stake in the LP but control its operations. Partnership agreements usually require GPs to distribute the bulk of partnership earnings to unitholders.

Many MLPs are controlled by larger entities that spun the businesses off, such as the diversified utility and energy company Oneok ($70; OKE), which controls Oneok Partners ($59; OKS). Some partnerships (such as LLCs) have no GP, while others have acquired their GP.

We looked at 17 LPs controlled by publicly traded GPs and found three trends worth noting:

• Every LP paid a higher yield than its GP.

• Of the partnerships with sufficient trading history, 73% of GPs delivered higher returns than their LPs over the last 12 months, while 78% of GPs outperformed over the last five years.

• GPs and LPs earn roughly similar Quadrix Overall scores. Both groups average Value scores below 50, but LPs' Value ranks are slightly higher than GPs'.

While high yields may move investors to favor LPs, we do not prefer one type of partnership over another. One massive GP, Kinder Morgan ($40; KMI) said last month that it would consolidate three other firms — including the MLPs Kinder Morgan Energy Partners ($96; KMP) and El Paso Pipeline Partners ($41; EPB) — into itself. For more on the deal, see Portfolio Review.

Because publicly traded partnerships use different accounting methods than corporations, they require a different type of analysis. Statistics such as earnings don't compare cleanly to traditional stocks. While we still give our Quadrix scores a lot of weight, they aren't designed for MLPs and may not be as effective a measure of investment quality. We consider several MLP-specific statistics in our analysis, particularly distributable cash flow (cash flow available for payment to unitholders) and two Quadrix scores that compare MLPs to other MLPs.

Trusting in real estate

Real estate stocks have trounced the market in recent months, with the S&P 1500 Real Estate Group Index returning 11.0% in the six months ended August, versus 7.6% for the S&P 1500 Financial Sector Index and 8.3% for the broader S&P 1500.

That outperformance is nothing new — real estate also topped the sector and broad-market indexes over the last five years. Since the start of 1996, the MSCI U.S. REIT Index has returned 605%, versus 384% for the S&P 1500 Index.

Does this mean real estate investment trusts will continue to outperform in the years ahead? Not necessarily. However, it does suggest that real estate follows its own trends. The group certainly didn't get hammered as much as the rest of the financial sector in 2008 and bounced back much faster.

Real estate lagged the financial sector in 2012 and 2013, as banks and other beleaguered financial-services providers recovered from crippling blows delivered by the financial crisis. However, real estate outperformed in each of the previous eight years, in many cases following a drastically different path than other financials.

This divergence illustrates the benefit of REITs as a tool to diversify portfolios.

Historically, REITs have been sensitive to interest rates, in part because the companies tend to carry a lot of debt and in part because rising interest rates make them less attractive relative to fixed-income securities. With interest rates at historically low levels, we expect them to rise over the next few years. However, nearly everybody expects interest rates to eventually move higher, and it's uncertain how much those increases will affect REITs.

On the positive side, vacancy rates are falling. According to CBRE, industrial vacancy rates have declined in 15 consecutive quarters ended March 2014, while retail vacancies fell below 12% for the first time since early 2009. Apartment vacancies are low compared to historical norms. In addition, investment in nonresidential fixed property has increased in each of the last 13 quarters, suggesting businesses are willing to spend on real estate. Such an environment could prove friendly to REITs.

The best of the bunch

As a group, the MLPs and REITs on our Alternative Income Watch List earn mediocre Quadrix scores, and we don't recommend any of them for purchase. However, a few earn decent scores and qualify for A (above average) ratings; check them out in the table below.

ALTERNATIVE INCOME OPTIONS
Below we present real estate investment trusts (REITs) and master limited partnerships (MLPs) from our Alternative Income Watch List. We present only securities earning A (above average) or B (average) ratings. Average yields and Quadrix scores take into account all 78 of our monitored REITs and MLPs, including those rated C (below average). For the complete list, visit www.DowTheory.com/go/alt.
------------- Quadrix Scores -------------
Company (Price; Ticker)
Div.
Yield
(%)
Value
Overall
12-
Factor
Sector
Reranked
Overall
Rank
Industry
REITs
American Tower
($99; AMT)
1.4
25
72
48
38
A
Specialized
Avalonbay
($154; AVB)
3.0
25
64
45
29
A
Residential
Boston Properties
($121; BXP)
2.1
22
47
32
20
B
Office
Equity Lifestyle
($46; ELS)
2.8
38
66
NA
NA
A
Residential
Equity Residential
($66; EQR)
3.1
21
65
46
28
A
Residential
Extra Space Storage
($53; EXR)
3.5
34
82
78
50
A
Specialized
Host Hotels &
Resorts ($23; HST)
3.5
31
59
33
29
A
Hotel & resort
Omega Healthcare
($38; OHI)
5.4
42
75
37
44
A
Health care
Public Storage
($175; PSA)
3.2
33
67
50
36
A
Specialized
Simon Property
($170; SPG)
3.1
32
49
50
27
B
Retail
REIT Average
4.2
31
45
27
20
MLPs
Alliance Holdings
($72; AHGP)
4.8
81
99
98
98
A
Coal & cons.
fuels
Allliance Resource
($50; ARLP)
5.0
86
99
97
98
A
Coal & cons.
fuels
AmeriGas Partners
($46; APU)
7.6
76
69
94
81
A
Gas utilities
Blackstone Group
($33; BX)
5.1
95
100
100
99
A
Asset mgmt.
Energy Transfer
Equity ($61; ETE)
2.5
33
47
79
52
B
Oil & gas
storage
Energy Transfer
Ptnrs. ($57; ETP)
6.7
68
74
83
79
A
Oil & gas
storage
Enterprise Products
($41; EPD)
3.5
27
36
78
35
B
Oil & gas
storage
Magellan Midstream
($83; MMP)
3.1
23
70
65
66
A
Oil & gas
storage
Och-Ziff Cap.
Mgmt. ($13; OZM)
5.5
88
78
90
92
A
Asset
mgmt.
Targa Resources
($74; NGLS)
4.2
42
87
96
80
A
Oil & gas
storage
MLP Average
5.2
43
53
70
51
Note: Quadrix scores are percentile ranks, with 100 the best. * We calculate 12-Factor scores for MLPs relative to other MLPs, not based on their sector. Ā  NA Not available.

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