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High current yields and growing dividends are the cure for the directionless market. And if we are in for a “lost decade” from the stock market, yield plus growing dividends is one strategy that will still produce positive total returns. The strategy works in any market—bull, bear, or stagnant.

Let me show you.

Over the last few years, master limited partnerships (MLPs) focused on growing free cash flow, providing a higher level of coverage for dividend payments. Starting in around 2017, these companies spent their time building cash flow with little to no dividend growth.

MLPs operate in the energy midstream sector. These companies own and manage assets such as pipelines, processing plants, and terminals. MLP revenues come from long-term, fee-based contracts. The midstream sector generates much more stable revenue than upstream drilling companies and downstream refiners.

Unique among midstream companies is the use of the MLP structure. Investors are technically limited partners instead of shareholders. There are some tax implications to MLP ownership that I will touch on below.

But first, let’s talk about cash flow for the MLP sector. A recent VettaFi article reported that MLP sector dividend coverage increased from 1.4 times in 2018 to 2.3 times in 2022. The coverage is the ratio of free cash flow divided by the dividends paid to investors. Five years ago, 1.2 to 1.4 times coverage was considered adequate.

From 2020 through 2022, MLPs stopped or slowed dividend growth while their free cash flow continued to grow. The major companies in the group all followed the same strategy to increase financial stability. Starting this year, the major MLPs really started to increase the distributions paid to investors. Here are a couple of examples:

• In November 2022, MPLX LP (MPLX) increased its dividend by 10%, compared to a 2.5% boost in 2021.
• In April 2022, Western Midstream Partners LP (WES) increased its dividend by 53%. The payout had previously grown by less than one percent per year.
• In January 2023, Plains All American Pipeline LP (PAA) increased its distribution by 23%. This was the second consecutive 20%-plus annual increase.

The Alerian MLP Infrastructure Index has a current yield of 7.9%. My research indicates the MLPs in the index are likely to grow their distributions by 8% to 10% per year going forward. A combination of 8% yield plus 8% dividend growth will produce mid-teens compounding annual returns over the long run.

Now, back to those tax implications: If you invest in an MLP, you will receive a Schedule K-1 for tax reporting. K-1 requires some extra work at tax time. Also, you should not own any K-1 MLP shares in a tax-qualified account such as an IRA; otherwise, there can be severe tax consequences.

On the plus side, MLP distributions are classified as a non-taxable return of capital. Instead, the distributions reduce your cost basis.

An MLP ETF allows you to receive 1099 for taxes but also passes through the return of capital tax advantage. The Alerian MLP ETF (AMLP) tracks the index and currently yields 7.8%. The InfraCap MLP ETF (AMZA) is actively managed and pays stable monthly dividends. AMZA currently yields 8.8%.

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