Oil prices appear to have settled around $50, half the level of last summer.
For income investors, that has played merry hell with the economics of energy master limited partnerships, previously considered one of the most attractive sources of high, stable dividends.
A number of energy MLPs have slashed their dividends, and even appear likely to operate at a loss going forward. However, there are still substantial parts of the sector where dividends appear more reliable, and income investors should seek out these lucrative opportunities.
The biggest problems have arisen in energy MLPs that own reserves and produce oil from them, which isn’t surprising. After all, if the price of your product halves, you’re bound to struggle. But it also reflects a deeper reality: Many MLPs represent pools of assets spun off in recent years with relatively high cost bases.
Now, a Saudi Arabian MLP would still be profitable, because Saudi Arabia’s production costs are a fraction of the current oil prices. However, marginal producers in high-cost sectors, especially those using expensive “fracking” techniques, are much harder to manage.
Mining the Midstream
In the middle are pipeline, transmission, and storage MLPs that make their money from transporting and storing energy. Lower energy prices are generally beneficial for these MLPs, as lower prices increase demand, consumption, and throughput. On the other hand, if they own oil or receive revenue on a percentage-royalty basis, they may be exposed to price declines.
Recently, their earnings have been relatively strong, but the largest and most stable of these companies tend to have high price tags. Enbridge Energy Partners (EEP), for example, has a forward P/E multiple of 27x (and a trailing P/E of infinity), although its 5.9% dividend yield is attractive.
Plains All American Pipeline (PAA), a $19-billion MLP, has a yield of 5.2% and a forward P/E multiple of a somewhat more reasonable 19.8x. Both of these companies earn less than the dividends they pay, because pipelines can be depreciated, causing non-cash operating costs. Conversely, they have a finite life, so their earnings may be a truer guide to their value than the dividends.
Finally, World Point Terminals (WPT), which stores refined and crude oil products, has a dividend yield of 6% and a forward P/E multiple of a slightly more reasonable 17.2x. All three of these companies are attractive income investments in today’s low-interest-rate world, because their profits are more or less independent of oil prices.
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Finally, there’s one group of income-oriented companies that benefits from oil price declines: MLPs that own refinery assets.
Oil refineries benefit from falling crude prices in several ways. First, a decline in the price of gasoline and other oil products increases consumption. Motorists drive more and switch to more gas-guzzling cars, SUVs, and trucks, while many energy users switch to petroleum products.
Refineries may also benefit from weak crude prices because their output prices can be held “sticky” as their input prices decline.
Of course, refining company earnings fluctuate greatly from quarter to quarter, which normally leads dividends to be highly variable, as well. To get around this problem, some refining companies pay dividends out of capital in periods when earnings are depressed – though, you should worry about the extent to which the investment is self-liquidating. You don’t want it to leave you with nothing after a relatively short period.
And since refineries themselves have a finite life, require refurbishment, and deliver a fluctuating cash flow, there’s a fair amount of risk inherent when investing in them, especially over a very long period, such as retirement.
Still, their yields can be truly attractive in periods of weak oil prices. Thus, I’ve identified three refinery assets worth considering in today’s environment:
Refinery Asset No. 1: Calumet Specialty Products Partners (CLMT). Calumet specializes in the kind of offbeat petroleum-related products with sales volume that can increase rapidly when prices fall. Its quarterly dividend was $0.63 in 2008, then fell to $0.45 during the 2009 recession as sales of its varied product line fell. Since then, it has recovered to a current level of $0.685, giving it a yield of 10.8% at current prices. However, third-quarter earnings were only $0.08 per share after $0.25 of derivatives losses – nowhere near covering the current dividend. Fourth-quarter earnings are due February 27. If they exceed the quarter’s dividend, this looks like a good “Buy.”
Refinery Asset No. 2: Northern Tier Energy (NTI). Northern will give you a truly spectacular current yield of 12.7%, based on the last four quarters’ dividends, and it appears able to justify that from current operations. However, it went public only in 2012, and quarterly dividends since then have fluctuated from $0.31 to $1.48 – the classic profile of a refinery MLP. NTI made $1.04 per unit in the third quarter and distributed $1, but its fourth-quarter dividend, to be paid February 27, was a somewhat disappointing $0.49. Still, that yield is very attractive, and unlike CLMT, NTI doesn’t seem to pay out more than it earns.
Refinery Asset No. 3: CVR Refining (CVRR). CVR Refining is a large refiner in Coffeyville, Kansas, with shares currently yielding 10.7%, based on the last four quarters’ dividends. But the latest dividend, with an ex-dividend date of February 26, was only $0.37 – and fourth-quarter earnings showed a loss of $112 million because of a FIFO accounting loss of $154.6 million (a one-off caused by the fall in oil prices). For the year as a whole, CVRR made $2.43 per share and paid dividends of $2.16.
Which refinery you buy depends on how much risk you want… but the right energy MLPs are still worth looking at.
For more information about MLPs and guidance regarding several income-related strategies, check out Marc Lichtenfeld’s Get Rich With Dividends. The second edition of this bestselling book was just released.