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MLPs: Where Cash Flow Can Trump Confusion


Master limited partnerships can be excellent risk-adjusted investments.

As my firm takes the controversial opinion that there are a few line items in your own budget that will still inflate -- a prominent possibility is taxes -- this unique group is worth a peek, especially since so few do. That's the other advantage careful homework offers in this space more than most. Master limited partnerships (MLPs) are under-followed by Wall Street and under-owned institutionally. Among the silliest but most significant reasons for the apathy, is the "hassle" of K-1 forms to sort through in order to calculate lower personal taxes.

I wrote about Inergy (NRGY) earlier this year, among the MLPs we were knee-deep in researching. It stood out in our work as potentially set up well with the commodity prices at year-end down sharply, while retail prices they charge for propane remained sticky strong - and that was without the benefit of a historic cold snap. Well, with 2 more months of heating season still to go, they're out on the tape already raising guidance. Our homework assignment was fairly simple in a world which was increasingly difficult to figure out. We're looking for businesses with sustainable cash flow against the market's perception and valuation, which has changed the most.

We continue to hunt for additions to our multi-year holdings among the under-followed and often misunderstood MLPs. My firm believes that inside the Energy and Materials sectors, which were gutted last Fall, that this sub-group could be the most mis-priced.

The fear was that many members of the group sported yields that were in jeopardy to be cut in the first quarter. Note that yellow line above is not yields - it's actual distributions. Less scrutinized may have been the underlying fundamentals, liquidity, and hedges in place to cover many of them, my firm's work led us to believe. All while the prices for the publicly traded units fell to historically distressed levels. Unlike many traps among common stocks, where yields were only going up because prices were collapsing, this group was doing something different. 44 out of 46 MLPs my firm tracks have just raised their distributions year over year in the first quarter and the majority raised them quarter over quarter as well.

Their combined market cap is around $84 billion, otherwise known as about one-sixth the cost of Exxon (XOM) alone, whose fully taxable dividend yield is 2%. By comparison, this group of MLP's average yield is in the double-digits, which are heavily shielded from personal income taxes (with some restrictions).
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Positions in NRP, NRGY.
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