Because of new higher tax rates on dividends and capital gains
for upper-bracket earners this year, it's more important than ever
to chooseinvestments that are worth holding for the long-term and
that grow their dividends. The best way to offset the negative
effects of these new tax hikes is through a risingdividend , which
also offersinflation protection and support for the share
price.
Consider the example of astock yielding 5% with a $100 share
price and $5 per-share dividend. An increase in the dividendtax
rate from 15% to 20% reduces this stock's after-tax income to $4
per share from $4.25 ($5 - 20% = $4). But if the stock also grows
its dividend by a 5% annual rate, then income quickly rises despite
the tax hike. Within five years, this stockwill be paying a $6.38
per-share dividend that yields after-tax income of $5.11. That's
considerably more than the $4.25 per share of income collected
initially at the 15% tax rate.
Growth in $5 dividend climbing 5% a year
A great place to look for rising dividends is among energy
master limited partnerships (MLPs). These companies typically
provide energy-related services under long-term contracts that
generate the reliablecash flow necessary for a growing
dividend.
The strength of MLP dividends became apparent during
therecession when household names such as
General Electric (
GE
)
and
Pfizer (
PFE
)
were forced to cut dividends. In contrast, most MLPs maintained
payouts during the downturn, even as energy prices collapsed. MLPs
that own midstream assets such as pipelines are especially
resilient since their mostly fee-based income is largely insulated
from energy price changes.
Similar toreal estate investment trusts, MLPs are required to
pay at least 90% of their income as distributions to theirlimited
partners , the unitholders. These payments are only taxable when
the units are sold (ownership in an MLP is in "units" rather
thanshares ). This is why investors shouldbuy and hold the units
for long periods or even through retirement, when retirees
typically move to a lowertax bracket . [Stocks like these are what
Carla Pasternak, chief investment strategist of
High-YieldInvesting
, calls
Retirement Savings Stocks
.]
To pick the best MLPs for abuy-and-hold strategy, I focused on
companies that have strong operating performance, consistent
distribution growth and solid distribution coverage. Taking into
account the new higher dividend tax rate, I gave distribution
growth a larger weighting than the current yield
.
These three MLPs measured up on all three fronts, making them
great
Retirement Savings Stocks
. You can buy the shares today and expect to collect a rising
distribution in the future.
1.
Oneok Partners LP
Yield: 5% |
.jpg)
Oneok Partners (
OSK
)
owns major natural gas liquids (NGL) pipelines that connect
producers in the mid-continent and Rocky Mountain regions
with end-markets in other regions. The company's pipelines
carry nearly one-fifth of the gas exported from Canada to
the United States
New pipeline projects that came online last year fueled
a 27% year-over-year rise in Oneok'searnings per unit to
$2.38 during the first nine months of 2012.EBITDA , a key
cash flow metric for MLPs, improved 16% to $979.3 million
in the first threequarters of 2013 from $842.1 million a
year earlier.
Oneok has another $4.2 billion of expansion projects
planned through 2014, including pipelines serving the
Bakken Shale, and Canadian Woodford and GraniteWash energy
plays, which can drive future gains. In addition, Oneok has
a $2 billionbacklog of announced natural gas and NGL
infrastructure projects.
This MLP has increased distributions 6% a year for five
years and 20% since 2011. At present, Oneok pays an annual
distribution of $2.74 a unit, yielding almost 5%. Cash flow
coverage of the distribution is solid at 145%. Oneok aims
to grow distributions 10-15% a year and EBITDA 17-21%
annually through 2015.
|
2.
Magellan Midstream Partners LP
Yield: 4% |
.jpg)
Magellan Midstream Partners (
MMP
)
owns the longest refined petroleum pipeline in the United
States, with access to more than 40% of the nation's
refining capacity. The company owns more than 9,600 miles
of pipeline, 50 terminals and 80 million barrels of
petroleum storage capacity.
Magellan's growth will come from $1.3 billion of new
investments in crude oil pipelines, particularly in the
Permian Basin, where it's just beginning to tap into the
Permian crude oil boom. The company's Permian assets are
slated to become operational in mid-2013.
During the trailing 12 months ended in September 2012,
Magellan's earnings improved 29% to $392 million from a
year earlier, while EBITDA rose 11% to $599 million from
$540 million in the same period. Per-unit distributable
cash flow was $2.17 and provided more than 130%
distribution coverage.
Magellan has increased its distribution 43 times and at
a 12% annual rate since 2001. The last increase was in
January to a new annualized rate of $2 per unit, yielding
about 4%. The company targets a 10% distribution growth in
2013.
|
3.
SunocoLogistics Partners LP
Yield: 4% |
Sunoco Logistics Partners (
SXL
)
owns a geographically diverse portfolio of pipelines,
terminals and crude oil marketing assets. The company owns
5,400 miles of crude oil pipelines located mainly in
Oklahoma and Texas, terminal facilities on the Texas Gulf
Coast and a 2,500-mile pipeline of refined product.
Sunoco'sgeneral partner is owned by
Energy Transfer Partners L.P. (ETP)
.
The MLP's earnings per unit climbed 61% to $3.14 during
the first nine months of 2012. EBITDA jumped 76% to $555
million from $379 million in the same period. Cash flow
coverage of the distribution was impressive at 240%.
Sunoco's growth will likely be driven by new projects
coming online in 2013 and 2014. These include a Permian
Basin pipeline connecting West Texas producers and Gulf
Coast refiners and an Allegheny pipeline linking Midwest
refiners with markets in Ohio and Pennsylvania.
This fast-growing MLP has delivered six straight
quarters of positive earnings surprises and 31 consecutive
quarters of distribution hikes. The latest distribution
increase was a 5% hike in January to a new annualized rate
of $2.07 a unit yielding about 3.5%.
|
Risks to Consider:
As I've said before, MLPs are pass-through entities that
transferprofit or losses to individual unit holders, who paytaxes
at theirordinary income rate. Because MLPs pay the majority of
their earnings to unit holders, these companies typically rely on
debt orequity financings tofund growth initiatives.
Because ofdepreciation , the InternalRevenue Service
considers most of the MLP's distribution as areturn of capital ,
so it's not taxed in the current year. Instead, this portion of
the distribution isn't taxed until units are sold. Return of
capital also reduces thecost basis in the MLP.
Action to Take --->
My top pick for distribution growth and safety is Sunoco Logistics
Partners. Magellan and Oneok are also strong picks for investors
who prefer a higheryield and are willing to accept a more modest
distribution growth.