The best MLP you've never heard of

This little-known energy partnership offers superior profits and a nearly 8% yield.

By StreetAuthority Apr 26, 2013 9:30AM
Oil drums © Kevin Phillips Digital Vision age fotostockBy Lisa Springer

You would think a master limited partnership (MLP) that has outperformed its industry peers by 88% and the Nasdaq by 34% in the past five years -- while yielding an average of 8.8% -- would be well-known to investors.

But this MLP flies under the radar. No Wall Street analysts follow this company, and institutions hold only 11% of its shares.

However, if you're looking for a profitable high yielder poised for growth from rising energy prices, this is a name you should know. 

The stock I'm talking about is Dorchester Minerals (DMLP), an energy MLP formed in 2003 through a merger of three smaller companies.

Dorchester generates revenue from royalties it collects from the oil and gas wells on its properties, which total 3 million acres spread across 25 states. Dorchester has exposure to many of North America's most prolific gas fields, including the Fayetteville Shale, the Bakken formation, the Appalachian Basin, the Barnett Shale, the Permian Basin and the Granite Wash.
 
Perhaps best of all, only about 30% of Dorchester's holdings are developed. That adds to the potential for a rising income stream as new wells are drilled.

Unlike conventional oil and gas drillers, Dorchester has no exposure to the costs and risks of exploration, development and production. Instead, the company collects a royalty based on the sales volume of each well after the driller recoups 150% of well expenses.

Because royalty payments are directly affected by the selling price of natural gas Dorchester generates more cash flow when natural gas prices are rising.

Dorchester also differs from many of its MLP peers in that its general partner's fee is fixed at 4%. There are no distribution rights or incentives that increase the general partner's percentage on higher profits. Dorchester unit holders can count on consistently collecting 96% of the MLP's cash flow.

The improving outlook for natural gas demand and prices means this may be an especially good time to own Dorchester. Futures prices for natural gas surged to a 20-month high in April in response to an unusually cold spring that drained stockpiles. This prompted Goldman Sachs to raise its outlook for 2013 natural gas prices by 17%.



Natural gas accounts for roughly 75% of its reserves. Historically, Dorchester has been able to offset production declines from a steady stream of new wells on its acreage.

During 2012, 490 new wells were completed on the MLP's properties.

Despite low natural gas prices that led to reduced drilling activity in many of the company's producing areas, Dorchester produced respectable results in 2012. Revenue fell 9% from a year earlier to $63.2 million, but that was still the second-highest in four years. Net income was $38 million or $1.20 a share, down only 10% from a year earlier.

Despite its reduced earnings, Dorchester's cash flow actually improved 2% in 2012 to $56.4 million from a year earlier, and the MLP paid distributions of $1.79 a share to unit holders, an 8% increase over 2011.

Dorchester ended 2012 with cash of $13.8 million and no long-term debt. In fact, the company's charter precludes Dorchester from taking on long-term debt. But even without the benefit of leverage, Dorchester has been able to consistently produce returns that exceed its industry peers.

In the past five years, Dorchester's operating margins have averaged 62%, which is more than four times the average 15% margin of its industry competitors. Dorchester's five-year average return on assets is 28%, nearly three times its peer group average of 10%.

Company insiders show their confidence in Dorchester's future prospects by owning a healthy 9% of shares. Another sign of management's confidence is a 3.5% increase in the distribution, to 45 cents a share. Since 2009, Dorchester has increased its annualized distribution 19%.

Consensus analyst estimates forecast 5% earnings growth for Dorchester's industry peers this year, accelerating to 6% next year. I think it's likely that Dorchester can beat that estimate, thanks to its unhedged exposure to further increases in natural gas prices.

Risks to consider: Dorchester typically pays out 87% of operating cash flow as distributions. However, the amount may fluctuate due to the volatility of natural gas prices. For example, Dorchester's distributions dipped from $2.80 in 2008 to $1.50 in 2009 before rising to $1.65 in 2010 and $1.79 in 2012. Some income investors may find the variability of Dorchester's distribution too risky. 

Action to take --> Dorchester is an appealing stock for investors who want generous income and exposure to rising energy prices. I like this MLP because of its industry-leading profitability, low-risk profile, significant land holdings and untapped reserves.

Lisa Springer does not personally hold positions in any securities mentioned in this article. 

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