Master Limited Partnerships (MLP’s) are limited by US Code to only apply to enterprises that engage in certain businesses, mostly pertaining to the use of natural resources, such as petroleum and natural gas extraction and transportation. They combine the tax advantages of a partnership and higher dividend yields with the day to day tradability of common stocks.
MLP’s consist of a general partner who manages the operations and limited partners who own the rest of the units for the partnership. Unlike corporations MLP’s are not subject to double taxation.
Their stocks are called units, while their dividends are called distributions. The units are very easy to buy and sell, as they trade just like any other stock on NYSE, Nasdaq and AMEX.
MLP’s mail individualized K-1 tax forms to each unit holder in late February or early March of each year that specifies the tax treatment of the prior year's payouts. A portion of their payouts can be tax-deferred, and it is subtracted from ones cost basis. When you sell your units, some of the gain that comes from certain deductions such as depreciation expense will be taxed as ordinary income. Further, most MLP’s enjoy a pass through taxation of their income to partners, which avoid double taxation of earnings.
The majority of Master Limited Partnerships engage in the transportation and storage of natural resources such as refined petroleum products and natural gas.
Thus MLP’s typically enjoy toll-road business models. Thus:
● They do not take title to the commodities transported
● Are mostly indifferent to fluctuations in commodity prices because they are paid to transport not produce commodities
● They do not have significant credit risk as commodity prices balloon.
● MLP’s receive a fixed fee for moving a product over a certain distance through their pipelines
Other qualities that enable these stable enterprises to keep increasing their dividends over time include:
● Long Useful Lives of their assets
● Fees are indexed to inflation, which provides an inflation hedge
● Most MLP’s have a near monopoly in their area
● There is a high cost of entry and thus there is virtually no competition
● Most MLP’s have the ability to grow their cash flow base, so they could relatively outperform in a rising interest rate environment.
The benchmark for Master Limited Partnerships, the Alerian MLP Index, has enjoyed above average annual total returns of 11.90% from 1995 to 2008. Part of the strong performance could be attributed to the above average distribution yields that most MLP’s enjoy, coupled with strong growth in distributions. Master limited partnerships generate predictable and growing cash flows, which are somewhat immune to commodities price volatility and overall economic conditions.
L&S Advisors has a particular expertise with regards to MLP’s and is just one example of the strategies and tactics that we share with our clients specific to risk management.
Due to the legal structure, tax implications, and tax filings, Master Limited Partnerships (MLP’s), may not be suitable for certain types of accounts.
