3 MLPs That Are Attractive For High Yields And Safety

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Inflation has skyrocketed to a 40-year high this year due to the unprecedented fiscal stimulus packages offered by the government in response to the pandemic and the ongoing war in Ukraine. Even worse, inflation was initially characterized by the Fed as transitory but it has remained excessive for much longer than initially expected. Consequently, investors are currently struggling to protect the real value of their portfolios from eroding. Some MLPs are attractive in the current investing environment, as they offer tax-advantaged income and above-average yields. In this article, we will discuss the prospects of three MLPs that offer exceptionally high distribution yields with a wide margin of safety.

Magellan Midstream Partners (MMP)

Magellan Midstream Partners has the longest pipeline system of refined products, which is linked to almost 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 generate the remaining 35% of the operating income.

The key advantage of MMP is its tollbooth-like, fee-based model. MMP charges a fee for every barrel of crude oil and refined product transported or stored in its immense network. Thanks to the defensive business model of MMP, only 9% of its operating income is directly affected by commodity prices. As a result, the MLP has proved markedly resilient to recessions and downturns in the energy sector. In the fierce downturn of the energy sector in 2020, when global oil demand collapsed, most oil producers and refiners incurred excessive losses but MMP posted just an 18% decrease in its distributable cash flow per unit.

Moreover, MMP is now recovering strongly from the pandemic thanks to the recovery of global oil consumption and the sanctions of western countries on Russia for its invasion of Ukraine. Due to these sanctions, Russia has significantly reduced its production of oil and refined products and a great portion of these lost barrels has been made up by U.S. oil producers. U.S. shale oil production is expected by the Energy Information Administration to climb to a new all-time high in November while the total U.S. oil production is recovering towards its pre-pandemic high. These facts undoubtedly bode well for the volumes that will be transported and stored in the network of MMP. To cut a long story short, the business landscape is certainly favorable for MMP right now.

MMP grew its distribution for 70 consecutive quarters until it froze its distribution for seven consecutive quarters in 2020-2021 due to the pandemic. As the MLP proved resilient to the pandemic, it maintained its streak of annual distribution raises and thus it has now grown its distribution for 20 consecutive years. Moreover, it is currently offering an above-average yield of 8.3%. Given its reasonable payout ratio (for an MLP) of 80%, its healthy balance sheet, and its resilience to downturns, MMP is likely to continue raising its distribution for many more years, albeit at a slow pace.

Holly Energy Partners (HEP)

Holly Energy Partners operates a network of pipelines and storage terminals for crude oil and refined products. Its network extends to ten U.S. states, including Texas, Nevada, and Washington. HEP also has refinery facilities in Utah and Kansas. It was founded in 2004 by HF Sinclair (DINO) and generates revenue by charging its customers a fee for transporting and storing oil and refined products.

Just like MMP, HEP has a fee-based business model, which has repeatedly proved resilient during downturns. To be sure, the company posted essentially flat distributable cash flow per unit during 2019-2021, despite the fierce downturn of the energy sector caused by the unprecedented lockdowns. The key behind the impressive resilience of HEP is the take-or-pay feature of its contracts, which forces the customers to pay minimum amounts to HEP even if they end up transporting much lower volumes than usual. Even better, the MLP has fully recovered from the pandemic, as its transported and stored volumes currently exceed pre-pandemic levels.

Despite its proven resilience to downturns. HEP cut its distribution by 50% at the onset of the pandemic, in a precautionary move amid high uncertainty. Since then, the MLP has kept its distribution flat but it is currently offering an above-average yield of 7.8%. Given its solid payout ratio of 53%, its strong balance sheet, and its defensive business model, its distribution is safe for the foreseeable future.

Suburban Propane Partners (SPH)

Suburban Propane Partners has been in operation since 1928 and became an MLP in 1996. It provides most of the U.S. with propane and other energy sources, with propane comprising approximately 90% of total revenue. Suburban serves about one million customers in 41 states.

Propane is a basic necessity, as it is used for heating, cooking, and agricultural purposes. It is also much cleaner than fossil fuels, such as fuel oil and coal, and hence its consumption is hardly affected by the environmental policies that have a goal of reducing the emissions of carbon dioxide. In addition, propane is usually cheaper than electricity as a heating source and hence it is the preferred source of heat for most customers.

Moreover, the propane industry is highly fragmented and thus it offers ample room for future growth to Suburban. The company has performed a long series of acquisitions and is likely to continue acquiring smaller propane distributors for many more years.

On the other hand, the earnings of Suburban are highly sensitive to the underlying weather conditions. The company enjoys excessive profits during harsh winters but its earnings slump during abnormally warm winters. Therefore, the stock is suitable only for patient investors, who can tolerate the inevitable gyrations of weather conditions and the resultant volatility in the results of Suburban.

Suburban is attractively valued right now. The stock is trading at a 10-year low price-to-earnings ratio of 3.9 while it is offering a distribution yield of 8.1%. Given its solid payout ratio of 31% and its decent balance sheet, its distribution has a wide margin of safety. Even if the 10-year low free cash flow per unit of $1.95 is used in the calculation of the payout ratio, the distribution is covered with a payout ratio of 67%. Therefore, investors can lock in an exceptionally high yield and rest assured that the distribution is safe.

Final Thoughts

The above three MLPs offer exceptionally high distribution yields with a wide margin of safety. They are thus attractive candidates in the ongoing bear market, as their generous distributions can make it much easier for investors to endure this painful phase of the stock market. The only caveat is the fact that investors should expect modest distribution raises from these MLPs due to their lackluster growth prospects.

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Disclosure: The author does not own any of the stocks mentioned in the article.

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