A High Quality Dividend Stock On Sale For $11 That Pays A 21% Yield

2014 was a year of divergence for the two major types of pass-through income stocks. Real estate investment trusts – REITs – had a great year, with the Dow Jones REIT index posting a 32.4% total return for the year. The other class of income stocks, master limited partnerships – MLPs – was hit by falling crude and natural gas prices, which led to a general sell-off across the energy sector. The Alerian MLP index lost 12% in the fourth quarter, to end up down 0.9% for the year. Distributions pulled the index’s total return back up to a positive 4.8%. The Alerian index is heavily weighted to the large-cap MLPs and does not well represent the sector. The equal weight version of the MLP index lost 11.9% for 2014.

Investors panicked as it appeared crude oil had fallen off a cliff.

Fear about MLPs remains in the market, with crude oil below $50 per barrel and down over 50% since mid-2014. Almost all you hear or read from the news media is how oil will next go to $30 or we are in for a long period of sub-$50 oil, which will hammer energy sector profits. However, the history of crude oil prices does not support that outlook. This fact was recently provided on CNBC:

“Oil has sold off 50% within 6 months a total of 5 times since 1980. In the 6 months following the previous declines oil was up 5 out of 5 times, and the average gain was a whopping 52%.”

The energy commodities – especially crude oil – have unique characteristics that make it highly unlikely that prices can stay down for an extended period of time:

• The production of an oil well declines over time. On average, wells around the world lose 10% to 15% of their daily production rates every year.
• In most parts of the world it is expensive to drill new wells to bring on new production to replace the rate of decline and/or grow overall production. Many energy plays need $90 to $100 oil to justify the cost of new exploration and drilling.
• Every day the world consumes an amount of crude oil that is very close to the amount produced.

Low oil prices lead to less production, which quickly leads to an under supply situation, which will drive the price of oil back up again. With the price of oil down and energy stock share prices down, now is the time to buy quality MLP units at prices that may be the new lows before the next up leg. Think of buying MLPs in January 2015 as the equivalent of buying large-cap stocks in March 2009. Remember those days when no one wanted to own stocks and the market went up by 300% over the next 5 years?

Upstream MLPs own and operate producing oil and gas wells. This sector of MLPs is most exposed to energy commodity price swings. The upstream companies make extensive use of derivative contracts to lock in the prices they will receive for the planned oil and gas production for up to three years in the future. In most market conditions, the hedging practices allow upstream MLPs to maintain their distribution through a range of energy prices. The recent drop in prices for oil and natural gas have driven down the upstream unit prices, offering high-yield bargains if you think energy prices will recover in 2015.

On January 2, upstream MLP Linn Energy LLC (Nasdaq: LINE)announced new budget plans for 2015 with a 52% lower distribution to be paid to investors. Linn is now positioned to maintain an 11% yield at $60 crude oil and can grow the distribution if the price of crude goes up.

Legacy Reserves LP (Nasdaq: LGCY) is a conservatively managed upstream MLP that maintained its distribution rate in 2008 when oil dropped from $140 down into the $30’s and then recovered over the next two years. If Legacy can keep up its distribution this time around, investors who buy now will earn an eye-popping 21% yield.

Midstream MLPs provide energy collection, processing, transport and storage services. These companies generate fee-based revenues and have less exposure to energy commodity prices. Oneok Partners LP (NYSE: OKS) primarily provides natural gas related midstream services. Oneok does have some commodity price exposure allowing the company to increase profits when energy prices increase. OKS is down 20% in the last year and now yields 7.75%. Oneok Partners should grow distributions by at least 6% in 2015.