Yield Seekers: Have You Spotted This Great Opportunity?
In a move to settle edgy markets, the Fed recently postponed a highly-anticipated interest rate increase. But that doesn't mean a hike isn't still on the way.
In fact, now is the perfect time for income-focused investors to start thinking about how your various investments will be impacted by the inevitable rise in interest rates.
In a rising rate environment, there are a few industries and types of companies that are seen as less favorable than others.
Take regulated utilities, for instance.
Utility companies (or power companies) are regulated by states or municipalities and don't have control over the rates they charge their customers. They are subject to pricing caps, which limit their profit margins.
So these utilities are typically reliant on debt and equity offerings to fund projects, such as network upgrades and expansions. That makes them extremely susceptible to liquidity challenges when rates go up.
Another industry that is perceived to be hurt by rising rates: master limited partnerships (MLPs).
This view, however, is not entirely accurate.
Let's look deeper. An MLP is a company that is structured to pass through its profits directly to its owners, or partners. That's why they are also called "pass-through entities."
MLPs can target a range of industries, but are often associated with the energy industry. Here's how these partnerships operate.
Our nation continues to need more and more pipelines to transport a range of gases and liquids, though such pipelines are very expensive to build.
To entice a large-enough group of investors (limited partners) to help fund the deployment of new pipelines, a smaller group of interested investors (the general partner) start a new partnership. This new partnership comes with some pretty enticing benefits:
1. At least 90% of all profits that come from its business must be passed on to its limited partners.
2. All of the income that is passed through is exempt from corporate taxes, thus avoiding the problem of double-taxation.
In addition to these two main benefits, most MLPs operate almost like small monopolies. After all, the cost to get into this game is expensive -- at least up front. But once their pipelines are in place, costs dramatically decline.
Unfortunately, because most of an MLP's income is passed directly onto its partners, there's not much money left for expansion or maintenance costs. That's why these MLPs must rely on debt markets, similar to utilities.
That's why most income investors fear MLPs when rates are going up. They are sensitive to interest rates.Some MLPs will feel a negative interest rate impact when the time comes. However, not all MLPs are created equally. In fact, because investors are already worried about this sector, there is one that is actually cheap right now... before rates are even rising.
Not only does this MLP have attractive valuations, the partnership will actually be able to thrive in a rising rate environment simply because of its size experience and stability.
Enterprise Products Partners (NYSE: EPD ) is one of the largest pipeline operators in the country. It has nearly 50,000 miles worth of natural gas pipelines that span from New York state to Wyoming. It also operates storage facilities, processing plants and fractionators.
But what makes EPD such a lucrative opportunity in the face of what is otherwise a disliked industry? It's impressive track record.
The partnership has absolutely exploded in size over the last several years, regardless of what rates or the economy was up to.
In 2004, the last time interest rates were low, EPD had a net income of just $268 million. Last year, the company netted $2.8 billion.
Think about that. From 2004 through 2007, rates were rising -- which in theory makes for a bad environment for MLPs like Enterprise. Then, from 2008 through 2010, the United States suffered through one of the worst economic periods on record. Yet, EPD grew its bottom line by nearly 1,000%.
Plus, since it has to pass through most of that fast-growing income to its owners, it's been able to more than double its quarterly distributions since 2004, on a per share basis. That makes it one of the most consistent dividend payers around.
So, despite what rates do from here, EPD has a track record to prove it can excel. In fact, since investors have been turning away from MLPs of late -- and because anything with the word "energy" in its title has been sold off -- Enterprise is actually quite a steal right now.
Because its income and distributions are so consistent due to its structure, a simple glance at its historical dividend yield shows just how cheap this stock is today.
Risks To Consider: Even though interest rates shouldn't affect EPD as much as some other MLPs, it operates in the volatile natural gas business. And with natural gas prices so low, many producers are packing up their wells. That means less volume for EPD's pipelines. If these prices hold for an extended time, Enterprise will see its growth slow.
Action To Take: Although investors are broadly shunning MLPs these days, you should give this super-steady operator a second look. Add shares of Enterprise Products Partners (NYSE: EPD ) as a contrarian position to take advantage of other investors' mistakes going into the inevitable rate hikes. You'll also be locking in a stellar yield.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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