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Master Limited Partnerships enjoy tax privileges and distribute almost all their earnings to their shareholders. As a result, they offer exceptionally high distribution yields and are great candidates for income investors.
This is especially true in the current investing environment, which is marked by the surge of inflation to a 40-year high level. Due to inflation, investors are struggling to protect the real value of their portfolios from eroding.
In this article, we will discuss the prospects of three highly attractive Master Limited Partnerships (MLPs), namely Magellan Midstream Partners (MMP), Holly Energy Partners (HEP) and Lazard (LAZ).
MLP #1: Magellan Midstream Partners
Magellan Midstream Partners has the longest pipeline system of refined products, which is linked to nearly half of the total U.S. refining capacity. This segment generates 65% of the total operating income of the MLP while the transportation and storage of crude oil generates the remaining 35% of operating income.
MMP has a fee-based model, with only 9% of operating income depending on commodity prices. As a result, MMP is extremely resilient to the boom-and-bust cycles of the energy market. To be sure, in 2020, when most oil majors and all the refiners incurred hefty losses due to the coronavirus crisis, MMP saw its distributable cash flow per share decrease only 18%. Even better, it did not cut its distribution and kept offering a yield around 10%, thus making it much easier for its shareholders to endure the fierce downturn.
MMP has exhibited much better performance than most MLPs over the last decade. Many MLPs carry high amounts of debt, post poor free cash flows due to their capital expenses and dilute their unitholders to a great extent on a regular basis. They also tend to have payout ratios near or above 100%. On the contrary, MMP has posted positive free cash flows every year for more than a decade and has a solid balance sheet. In addition, it does not dilute its shareholders and maintains a healthy payout ratio. All these characteristics confirm the discipline of its management to invest exclusively in high-return projects.
MMP has some significant competitive advantages, namely its defensive fee-based model, its great scale and its discipline to invest only in highly profitable projects. Thanks to these advantages, the MLP has an exceptional distribution growth record. It grew its distribution for 70 consecutive quarters and froze its dividend for seven quarters in 2020-2021 due to the pandemic, but it did not cut its distribution, in sharp contrast to many energy companies.
It is also worth noting that MMP has raised its annual distribution at an 11% average annual rate since 2001 and is currently offering a 7.9% yield. Given its healthy payout ratio (for an MLP) of 80%, its robust business model and its strong balance sheet, MMP is likely to keep raising its distribution for many more years. And instead of issuing new shares to fund growth projects, like most MLPs, MMP is now repurchasing its shares at low prices to enhance shareholder value. Overall, MMP is one of the highest-quality Master Limited Partnerships and is offering an exceptionally attractive distribution yield.
MLP #2: Holly Energy Partners
Holly Energy Partners owns essentially the whole pipeline network of crude oil and refined products as well as the terminal assets that support the refining and marketing business of HF Sinclair (DINO). Among others, this asset portfolio includes storage capacity of approximately 15 million barrels of refined products and 3,400 miles of pipelines of crude oil and refined products.
Just like Magellan Midstream Partners, HEP has a rock-solid business model in place. Nearly all its revenues are fee-based and approximately 75% of its revenues are based on minimum-volume contracts. In other words, its customers have to pay minimum amounts to HEP even if they transport and store lower quantities of oil and refined products than normal. Moreover, 70% of the revenues of HEP come from HF Sinclair, which owns 57% of the MLP and has contracts with the MLP for the next 10-15 years. To cut a long story short, the cash flows of HEP are as reliable and predictable as they can be in the energy sector.
HEP has proved its defensive nature throughout the coronavirus crisis. Even in 2020, when all the oil companies saw their earnings collapse, HEP grew its distributable cash flow per share 4%, from $2.58 to $2.69.
HEP also has an exceptional distribution record. It raised its distribution for 58 consecutive quarters at a 7% average annual rate until 2020. As this period includes the Great Recession and the collapse of the price of oil from $100 in 2014 to $26 in 2016, the distribution growth streak of HEP is a testament to its resilient business model.
Unfortunately, HEP slashed its distribution by 48% in 2020 due to the uncertainty caused by the pandemic. The company could marginally avoid cutting its distribution, as it reported a coverage ratio of 100.4% in that year. However, due to the uncertainty caused by the coronavirus crisis, management chose to reduce the distribution proactively in order to protect the MLP from the adverse scenario of a prolonged pandemic.
Despite the distribution cut, HEP is still offering an attractive distribution yield of 7.1%. Given the strong distribution coverage ratio of 1.7 of the MLP, its defensive business model and its healthy balance sheet, investors should rest assured that the 7.1% yield of the stock has a wide margin of safety.
MLP #3: Lazard
Lazard is one of the few MLPs that do not belong to the energy sector. It is an international investment advisory company, which was founded in 1848. It has two business segments, namely Financial Advisory and Asset Management, with approximately equal contribution to total revenues. The Financial Advisory business includes M&A, debt restructuring, capital raising and other advisory business. The Asset Management business is about 80% equities and focuses primarily on institutional clients.
Lazard enjoys some significant competitive advantages, such as its reputation for excellence and integrity, its global scale, its long-term relationships and its expertise in complex transactions. When countries or companies need to restructure their debt, the first company that comes to mind as an advisor is Lazard.
Lazard has proved more resilient than most financial stocks throughout the coronavirus crisis. In fact, the company is likely to greatly benefit from the pandemic in the upcoming years, as the health crisis has led most countries and numerous companies to issue excessive amounts of debt. Consequently, they will probably need to restructure their debt at some point in the future. This will provide a strong tailwind to the business of Lazard.
Furthermore, Lazard is currently offering a nearly 10-year high dividend yield of 5.4%. The high yield has resulted primarily from the 22% decline of the stock this year due to the war between Russia and Ukraine, which is likely to hurt global economic activity. In addition, the high inflation, which has partly resulted from this war, exerts pressure on the valuation of stocks, as it reduces the present value of future cash flows.
However, we view high inflation as a temporary headwind and expect inflation to revert towards normal levels within a few years. Moreover, Lazard has a healthy payout ratio of 44% and a solid balance sheet. As a result, the dividend has a wide margin of safety and those who lock in its 5.4% yield are likely to be highly rewarded whenever inflation reverts to normal levels.
Final Thoughts
After decades of low inflation, investors are facing a unique challenge this year, as they have to protect their portfolios from 40-year high inflation. Not only does inflation erode the real value of their portfolios, but it also exerts pressure on the valuation of stocks. The above three MLPs provide steady income to investors in the challenging investing landscape. They offer exceptionally high yields with a wide margin of safety.
