3/11/2014 7:15 PM ET|
The perils of chasing high yields
A plunge in the shares of one master limited partnership offers an instructive tale for yield-hungry investors.
More money has been lost reaching for yield than at the point of a gun. The truth of this Wall Street aphorism was on display at Boardwalk Pipeline Partners (BWP), a master limited partnership (MLP) that was yielding nearly 9 percent before it blew up, with its stock plunging 46 percent in one day.
The dangers of chasing yield are well worth keeping in mind whether you're investing in MLPs or in more-traditional stocks and bonds. In a yield-starved world, it's tempting to buy investments that pay high dividends. But high yields never come without high risks.
Boardwalk is an oil and gas pipeline company -- a supposedly safer way to invest in energy than buying stocks of regular oil and gas companies. It doesn't live or die based on changes in the always-volatile prices of oil and gas. Government regulators restrict the number of pipelines, which gives an advantage to existing pipeline owners.
Boardwalk is primarily a toll collector: Oil and gas companies pay to ship their product through Boardwalk's 14,450 miles of pipelines or to store it in the firm's underground storage caverns. Most transportation contracts run for years, ensuring relative stability in the firms' revenues and profits -- and investors' yields.
Organized as publicly traded limited partnerships, most MLPs pay no taxes at the corporate level. That's part of the reason for their fat distributions, which come in the form of ordinary income and may include the return of capital. The general partner manages the partnership, much like a CEO runs a traditional company. Investors are called unit holders instead of shareholders, and they receive K-1s instead of 1099s.
MLPs have surged in popularity in recent years. In 2000, the MLP universe consisted of just 18 companies with a combined market value of $14 billion, Barron's reports. The number of MLPs has swollen to 113, with a total market value of $460 billion. The tax code limits MLPs to companies in real estate, natural resources and other commodities.
Boardwalk had among the highest yields of its peers. That excited many investors. It should, of course, have been a red flag.
Before the market opened on Feb. 10, Boardwalk slashed its dividend by 81 percent, from 53.25 cents a quarter to 10 cents a quarter. The stock, which had closed the previous Friday at $24.09, cratered, closing at $13.01 on Feb. 10. It closed at $12.74 on Monday.
What went wrong? The biggest problem is that Boardwalk's pipelines are engaged primarily in shipping oil and gas from Texas and the Gulf Coast to the energy-hungry eastern U.S.
The game-changer is the increasing extraction of natural gas and oil from shale, particularly Pennsylvania's Marcellus Shale formation. The demand for energy from Boardwalk's pipelines has declined. And you can't just dig up a pipeline and move it somewhere else.
Oil and gas companies are renewing their contracts with Boardwalk at dramatically lower prices. What's more, Boardwalk owns natural gas in storage, but due to lack of demand, it doesn't expect to sell any gas this year. That, in turn, leads to higher maintenance and storage costs. Many pipeline companies buy and sell some oil and gas in addition to shipping it.
Boardwalk can't change geography, but it could have done a much better job of adapting to changing conditions. Shale is hardly a new story. Other pipeline companies have done much more.
Boardwalk's high payouts left too little money to reposition the company, says Matt Coffina, editor of the Morningstar Stock investor newsletter. Moreover, he says, Boardwalk borrowed too much money, was poorly managed and did a lousy job of keeping its shareholders up to date.
What should you buy instead? Coffina recommends Enterprise Products Partners (EPD). The yield is only 4.3 percent, but Enterprise continues to spend heavily on new pipelines, as well as becoming a processor, seller and exporter of natural gas liquids, which have a wide variety of uses, particularly in producing chemicals.
What's more, unlike Boardwalk, Enterprise isn't paying out virtually all of its income to investors. Instead, it's paying out about $1 of every $1.50 in income. That leaves money to reinvest in the business -- and to avoid a dividend cut, which, as Boardwalk illustrates, can have such a devastating effect on a stock's price.
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I took a haircut on BWP, after owning for years.
Lulled to sleep, collecting nice dividends until the day of the big drop.
Remember haters, managing money has pitfalls, too.
Nothing is guaranteed on this crazy, spinning orb we live on.
Senor;I agree with most of your statement.Pimco has a lot of fees to consider.For a while my
401k was with his fund and did great while the stock market was tanking.Luck was with me when I got out at the right.Sometimes it`s better to be lucky than good.
Do you understand what they do and is it a staple needed in both good times and bad?
How long have they paid a dividend and is it increasing over time?
These are good signs of a stable growing company which is exactly what you want.
Dont be in the front of the pack and dont be the one in the back..... Diversify, diversify, diversify...
One egg per basket please....
Always remember.... The early bird may get the worm, but the SECOND mouse gets the cheese!
Of the 25 Blue Chips I picked only two lost money (AT&T and HCP). The principal-preservation portfolio has produced a 20% annual return compared to 23% for the S&P 500 Index, including dividends. Nine of the 23 High Yield stocks lost money and three stocks alone accounted for half the gains: Pittney Bowes, SK Telecom Ltd, and Cellcom Israel Ltd. The first two have drastically lowered their dividend since then and the last is a lower, 7%, "high yield" stock.
The lesson I learned is that with my amateur but well-studied stock picking skills, the very high yield stocks are too risky to invest in unless a large number of different stocks is involved and even then it has much less chance of making money than the Blue Chips.
I'm sorry but the author does not seem to know much about MLPs or the energy market. All MLPs must distribute most of their earnings, therefore a high distribution rate can very easily be the result of excellent operations and future plans. The problem with Boardwalk is that they are one of the older MLPs and most of the pipelines they own run in the wrong direction and end at suppliers in the gulf and users in the Northeast. What is needed today is exactly the opposite. Pipelines can be reversed but it is much more complicated than one might think. Also the demand for and price of natural gas in the Northeast and Midwest was and still is very high due to the severe winter. I bought Enterprise Products Partners several years ago when it was yielding over 8%, but sold it for a nice profit when its yield was bid down below 5% (same with Magellan Midstream Partners). One needs to understand each MLPs business and buy the relatively high yielding ones flying under the radar.
The basic conclusion was that it's hard to lose principal with the Blue Chips but that most High Yields offer high yields to cover up the fact the company's finances can't keep the stock price up.
The return (all %'s including dividends) on the Blue Chips (McD's, Cracker Barrel O.C. Store, Johnson & Johnson, Wells Fargo, Target, Exxon, etc.) has been an annual 19.6%, slightly lagging the S&P 500 Index's 23.3% over the same period, with AT&T and HCP (Medical REIT) being the only companies out of 25 to lose money.
The return on the High Yields (Linn Energy, Pittney Bowes, Annaly Capital, Telefonica, etc.) has been an annual 12.0%, roughly half the market average, with 9 out of 23 stocks losing money. The Energy (mainly nat. gas) stocks generally took a pounding with Pittney Bowes (PBI, whose dividend was cut from 14% to yield 2.8% now), SK Telecom Co. LTD (SKM, whose dividend was cut from 12% to yield 0.9% now), and Cellcom Israel LTD (CEL, 7.4% yield) providing half the total gains. When the companies' fundamentals return to being able to hold up the stock price, the ridiculous dividend rates get cut!
Chasing down the K1 forms is not fun with mlp`s.Buy the MLP`s ina mutual fund and get the
statements from the fund company.
It's goes beyond this. is it- being lulled to sleep, or is it- being bamboozled into believing this is real? You know damn well in your head that all tangible factors keep falling but all manipulated factors keep rising, so you say... why disembark when the train keeps rolling on? Well, because it is a false train steadily decreasing it's capacity to stay on the rails. Bridge ahead. Many parts of it are missing and it cannot be repaired with an overloaded bandwagon train on it.
Birth, Growth, Maturity and Decline or Death. You tell me about inevitability. Since we see no decline, death is a foregone conclusion. Do you stay in the hole and revel in the game tokens, or get a life and plant a seed by buying into the next economy? It doesn't and won't recognize game tokens, for sure.
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