An Intro to MLPs, Part one

A master limited partnership (MLP) is a pass through structure much like a REIT. The limited partnerships are traded on exchanges as shares. Because they are structured as a partnership instead of a normal corporation they do not pay corporate level taxes. Rather, they are deferred to the limited partners who are taxed at their individual rate of their share of the partnership's income. This tax structure avoids the double taxation of dividends resulting in a much lower required cost of capital.

The distribution's made to limited partners come from the firms distributable cash flow instead of the partnership's income. The distributions are not taxed as they are incurred but are reduction in the cost basis of the investment creating a tax liability until the shares of the MLP are sold. This means that only a minimal amount of the distribution is considered taxable and the rest is a return of capital. Because of these tax exempt distributions an MLP should be owned in taxable account and distributions to tax exempt account and tax exempt institutions may be considered an UBIT. As a result, MLPs are generally only held in retail accounts as individual stocks or in a mutual fund.

For a company to qualify as an MLP, 90% of income must be received from qualifying sources such as natural resources, activities associated with natural resources (exploration, production, transportation, etc.), interest, income derived from real estate and the sale of assets. This results in companies predominantly from the energy sector being MLPs. 107 of 140 of publically traded MLPs are in the energy sector. The majority of these companies are either upstream or midstream companies. MLPs allow investors to expose themselves to natural resources without investing directly into the resource while maintaining a low beta.

Part 2 will consist of information pertaining to distributions, the history and the future of MLPs.

Comments (9)

Nov 11, 2013

This is what we need more of ... thanks

Nov 12, 2013

If you could delve into valuation and cost of capital assumptions/calculations that would be very helpful. Thanks.

Nov 12, 2013

Of course. I could get very detailed for those and include a model but that might have to get broken up into 2 additional parts. It would also focus on more of Energy MLP valuation and because they are valued differently than most companies and most MLPs are related to energy.

Nov 12, 2013

I still don't think the upstream has bottomed yet (drillers exploring for oil). The market usually takes a little bit of time to adjust upstream prices to reflect current projects going sour. Midstream and downstream could be interesting to load up on. Also if you're into yields and not just price appreciation, basically no midstream MLPs have lowered distributions.

It's hard to say for sure why MLP have gone down with oil price declines, but most people agree it has to do with a combination of fears that yields would get cut and that oil projects would become unprofitable with oil prices this low.

You're definitely on to something though. If you look at a lot of MLP Closed End Funds, they're trading at insane discounts to the actual underlying asset values.

I do agree that at least in Midstream MLPs the quality of businesses doesn't look like it's declined as much as their current prices would lead you to believe. This might be true in the Downstream as well. In the Upstream, I'm not convinced the MLPs are done going down yet.

  • Anonymous Monkey
  •  Nov 12, 2013

Really

  • Anonymous Monkey
  •  Nov 12, 2013

Midstream damage occurs a quarter or two after E&P bankruptcy, which can modify or cancel transport agreements. Assets closes to well head have greatest leverage. MLP Management may be waiting until these events occur before they change their outlook, so you need to be careful

Nov 12, 2013

Thanks to whoever just threw an SB to remind me of this. Crazy volatility. I got in...some around the time of this post (recovered a bit and then nosedived) and then sacked up again and bought more in February. Not selling yet.

Nov 13, 2018
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