Beat the new tax increases with these 3 MLPs

A great place to look for rising dividends is among energy master limited partnerships.

By MSN Money Partner Jan 31, 2013 1:28PM
Businessman offering money Andrea Bricco Brand X Pictures Getty ImagesBy Lisa Springer, StreetAuthority

Because of new higher tax rates on dividends and capital gains for upper-bracket earners this year, it's more important than ever to choose investments that are worth holding for the long term and that grow their dividends. The best way to offset the negative effects of these new tax hikes is through a rising dividend, which also offers inflation protection and support for the share price.

Consider the example of a stock yielding 5% with a $100 share price and $5 per-share dividend. An increase in the dividend tax rate from 15% to 20% reduces this stock's after-tax income to $4 per share from $4.25 ($5 - 20% = $4). But if the stock also grows its dividend by a 5% annual rate, then income quickly rises despite the tax hike. Within five years, this stock will be paying a $6.38 per-share dividend that yields after-tax income of $5.11. That's considerably more than the $4.25 per share of income collected initially at the 15% tax rate.

Growth in $5 dividend climbing 5% a year

A great place to look for rising dividends is among energy master limited partnerships (MLPs). These companies typically provide energy-related services under long-term contracts that generate the reliable cash flow necessary for a growing dividend.

The strength of MLP dividends became apparent during the recession when household names such as General Electric (GE) and Pfizer (PFE) were forced to cut dividends. In contrast, most MLPs maintained payouts during the downturn, even as energy prices collapsed. MLPs that own midstream assets such as pipelines are especially resilient since their mostly fee-based income is largely insulated from energy price changes.

Similar to real estate investment trusts, MLPs are required to pay at least 90% of their income as distributions to their limited partners, the unitholders. These payments are only taxable when the units are sold (ownership in an MLP is in "units" rather than shares). This is why investors should buy and hold the units for long periods or even through retirement, when retirees typically move to a lower tax bracket.

To pick the best MLPs for a buy-and-hold strategy, I focused on companies that have strong operating performance, consistent distribution growth and solid distribution coverage. Taking into account the new higher dividend tax rate, I gave distribution growth a larger weighting than the current yield.

These three MLPs measured up on all three fronts, making them great stocks for retirement. You can buy the shares today and expect to collect a rising distribution in the future.

1. Oneok Partners LP
Yield: 5%
Oneok Partners (OSK) owns major natural gas liquids (NGL) pipelines that connect producers in the mid-continent and Rocky Mountain regions with end-markets in other regions. The company's pipelines carry nearly one-fifth of the gas exported from Canada to the United States.

New pipeline projects that came online last year fueled a 27% year-over-year rise in Oneok's earnings per unit to $2.38 during the first nine months of 2012. EBITDA -- earnings before interest, taxes, depreciation, and amortization, a key cash flow metric for MLPs -- improved 16% to $979.3 million in the first three quarters of 2013 from $842.1 million a year earlier.

Oneok has another $4.2 billion of expansion projects planned through 2014, including pipelines serving the Bakken Shale, and Canadian Woodford and Granite Wash energy plays, which can drive future gains. In addition, Oneok has a $2 billion backlog of announced natural gas and NGL infrastructure projects.

This MLP has increased distributions 6% a year for five years and 20% since 2011. At present, Oneok pays an annual distribution of $2.74 a unit, yielding almost 5%. Cash flow coverage of the distribution is solid at 145%. Oneok aims to grow distributions 10%-15% a year and EBITDA 17%-21% annually through 2015.

2. Magellan Midstream Partners LP
Yield: 4%
Magellan Midstream Partners (MMP) owns the longest refined petroleum pipeline in the United States, with access to more than 40% of the nation's refining capacity. The company owns more than 9,600 miles of pipeline, 50 terminals and 80 million barrels of petroleum storage capacity.

Magellan's growth will come from $1.3 billion of new investments in crude oil pipelines, particularly in the Permian Basin, where it's just beginning to tap into the Permian crude oil boom. The company's Permian assets are slated to become operational in mid-2013.

During the trailing 12 months ended in September 2012, Magellan's earnings improved 29% to $392 million from a year earlier, while EBITDA rose 11% to $599 million from $540 million in the same period. Per-unit distributable cash flow was $2.17 and provided more than 130% distribution coverage.

Magellan has increased its distribution 43 times and at a 12% annual rate since 2001. The last increase was in January to a new annualized rate of $2 per unit, yielding about 4%. The company targets a 10% distribution growth in 2013.

3. Sunoco Logistics Partners LP
Yield: 4%
Sunoco Logistics Partners (SXL) owns a geographically diverse portfolio of pipelines, terminals and crude oil marketing assets. The company owns 5,400 miles of crude oil pipelines located mainly in Oklahoma and Texas, terminal facilities on the Texas Gulf Coast and a 2,500-mile pipeline of refined product. Sunoco's general partner is owned by Energy Transfer Partners L.P. (ETP).

The MLP's earnings per unit climbed 61% to $3.14 during the first nine months of 2012. EBITDA jumped 76% to $555 million from $379 million in the same period. Cash flow coverage of the distribution was impressive at 240%.

Sunoco's growth will likely be driven by new projects coming online in 2013 and 2014. These include a Permian Basin pipeline connecting West Texas producers and Gulf Coast refiners and an Allegheny pipeline linking Midwest refiners with markets in Ohio and Pennsylvania.

This fast-growing MLP has delivered six straight quarters of positive earnings surprises and 31 consecutive quarters of distribution hikes. The latest distribution increase was a 5% hike in January to a new annualized rate of $2.07 a unit yielding about 3.5%.

Risks to Consider: As I've said before, MLPs are pass-through entities that transfer profit or losses to individual unit holders, who pay taxes at their ordinary income rate. Because MLPs pay the majority of their earnings to unit holders, these companies typically rely on debt or equity financings to fund growth initiatives.

Because of depreciation, the Internal Revenue Service considers most of the MLPs' distribution as a return of capital, so it's not taxed in the current year. Instead, this portion of the distribution isn't taxed until units are sold. Return of capital also reduces the cost basis in the MLP.

Action to Take ---> My top pick for distribution growth and safety is Sunoco Logistics Partners. Magellan and Oneok are also strong picks for investors who prefer a higher yield and are willing to accept a more modest distribution growth.

More from StreetAuthority
12Comments
Jan 31, 2013 2:16PM
avatar

WHY NOT JUST IMPEACH OBAMA AND ALL DEMOCRAT SOCIALIST LIBERAL PIGS?

YEAH LIMO PAT I'M RIGHT WING YOU RIGHT IN YOUR FAT LIBERAL FACE! THE ONLY THING

RIGHT IN YOUR COMMENT IS THE LYING PART BUT IT'S OBAMA DOING THE LYING!

BENGHAZI? FAST N FURIOU? ECONOMY? TAX INCREASES? SOYLANDRA? GREEN ENERGY?

CLASH FOR CLUNKERS? I COULD GO ON ALL DAY JACKASS!

Jan 31, 2013 3:05PM
avatar

This should surprise no one. It was just a "make the little guy" feel good move to raise the rate on rich people. These folks know how to beat the tax man and the politicans know it better than anyone. If you hold your breath for true tax reform your going to turn blue.....

 

Next stop for Obama is a raise of tax on middle class citizens. We don't have the lawyer firepower to get out of it. JMHO

Jan 31, 2013 3:27PM
avatar
A "portion" of the dividend of MLPs is tax exempt because this is the portion of your investment that is being returned to you.  The remainder is treated as ordinary income and does not get a tax break as a stock dividend would.  Aside from the constant recalculating of the book value of the MLP that the IRS will want you to keep track of you are going to pay a higher tax rate on any "profits" you receive.  In the long term the loss of capital and higher tax rate require a lot more accounting savvy than running a few numbers and publishing an article to WOW your readers.
Jan 31, 2013 4:39PM
avatar

I never understand why financial writers pen articles that are geared to such a small percentage of the American population.

Simple:

Married couple with an AGI of less than $92.5K pay 0% on long term capital gains and qualified dividends.

So, buy an index fund (S&P 500, Total Stock Market, etc.)  and enjoy tax free gains.

I guess I'll never be a finance wizard. :) 

Jan 31, 2013 8:01PM
avatar

I commented on a similiar article previously regarding the statement that these distributions from partnerships are not taxable until sold.  True, the cash distributions from partnership are not taxable, per se, but the Schedule K-1 you receive as a partner while show your share of the partnership income it earned. This income is where the cash distributions come from!

 

Also, it implies that these so called dividends (actually distributions) are qualifying dividends subject to the lower 15% (persons whose modified income is below $200,000/$250,000) or the new 20% rates for those in the much higher tax brackets (See new tax law). I am not sure but the income the partnership earns are not dividends but fees for the use of pipelines etc. and those fees are not dividends.

Feb 1, 2013 12:08AM
avatar

BZURK....No I read part of it and the rest later....

 

I just get tired of NUTBALLS coming on and blowing crap....Fire with Fire..

Jan 31, 2013 2:39PM
avatar

There are a lot of very whacko far right conservatives on this planet...Or mostly U.S. ??

 

The thing that scares me is their OBSESSION with guns and CONTROL...

 

Once they go off the rails....They are School Shooters, Hostage takers, Cop Killers and the Like.

The Countries turn into Syria,Egypt and Libya...And other THIRD World Countries.

Jan 31, 2013 1:52PM
avatar

This is the type of articles we need.I`ts tiresome reading right wingers lying

about Obama.

Report
Please help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. They will investigate your report and take appropriate action. If necessary, they report all illegal activity to the proper authorities.
Categories
100 character limit
Are you sure you want to delete this comment?

DATA PROVIDERS

Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.

STOCK SCOUTER

StockScouter rates stocks from 1 to 10, with 10 being the best, using a system of advanced mathematics to determine a stock's expected risk and return. Ratings are displayed on a bell curve, meaning there will be fewer ratings of 1 and 10 and far more of 4 through 7.

120
120 rated 1
268
268 rated 2
439
439 rated 3
709
709 rated 4
641
641 rated 5
609
609 rated 6
640
640 rated 7
516
516 rated 8
272
272 rated 9
152
152 rated 10
12345678910

Top Picks

SYMBOLNAMERATING
EXCEXELON CORPORATION10
TAT&T Inc9
VZVERIZON COMMUNICATIONS8
CTLCENTURYLINK Inc8
AAPLAPPLE Inc10
More

VIDEO ON MSN MONEY

ABOUT

Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.

Contributors include professional investors and journalists affiliated with MSN Money.

Follow us on Twitter @topstocksmsn.