With bonds offering scanty returns, investors now trade more options to “reach for yield” in their portfolios, according to The Wall Street Journal.
This is dumb for two reasons.
1. Options are super risky. There’s a reason they are called the “crack cocaine” of the stock market. Sell a put to collect some income and you are on the hook for big losses if the stock tanks. Selling covered calls sounds safe, but you risk getting locked out of big gains if your stock suddenly moves up a lot.
2. You don’t need options to “reach for yield.” There are plenty of ways to get nice and relatively safe yield — plus the potential for capital appreciation — in the stock market. This is increasingly easy in energy, thanks to a continuing trend in energy pipelines and infrastructure.
Companies in this space pay relatively safe yields of 4%-6% or more — way better than the 1.96% yield on the S&P 500 SPX, -0.27% , the 2.65% yield on the Dow Jones Industrial Average DJIA, -0.41% or the 2.7% yield on 10-year U.S. Treasurys TMUBMUSD10Y, +0.03% .
What’s the trend that’s making it easier to collect yield here? Annoying master limited partnerships (MLPs) are increasingly converting to regular C corporations. This makes it a lot simpler to harvest yields in this space.
When boring is good
But first, let’s be clear that you will still be investing in boring businesses, even after the corporate conversions. They’re still the same old staid toll takers, collecting fees for moving energy through pipelines, processing it and storing it.
That’s a yawn, but boring is good because it means predictable. That’s what you want in an income investment. It suggests your dividends are less likely to vanish. After all, the fees are often set by regulators and long-term contracts. And they’re often inflation-indexed. This makes the cash flow that backs dividends more dependable.
Yet there’s potential upside from stock moves because these companies are plays on big-picture growth trends like the shale revolution and liquid natural gas (LNG) exports.
Before we get to six yield plays to consider, here are the three ways the conversion of MLPs to C corporations makes it more convenient to collect yield in the energy infrastructure space.
Thanks for help from Ben Cook and Lane French, portfolio manager and analyst for the Hennessy BP Midstream Fund HMSFX, +1.11% They know this space well and it shows in their returns. Their fund beats its Morningstar category by a percentage point annualized over the past five years.
1. You have fewer complications during tax time. MLPs have been a great way to book yield in the energy space, and to defer taxes. But they can create big headaches at tax time when the dreaded K-1 form lands. You may wind up having to file tax returns in several states. You might have to pay a business income tax if you hold them in tax-protected accounts. All of these headaches are gone when an MLP coverts to a C corporation.
2. You have more fellow investors. The tax related complications are a big reason why many people, including institutional investors, simply avoid MLPs. About 75% of C corporation shareholders are institutional investors compared to 46% for MLPs, says Cook. Having more potential investors around helps you, because it can mean more support for your stock. It also improves funding options for the companies.
3. You have better corporate governance. Not all MLPs are bad. But their structure creates a potential conflict of interest for top managers. In MLPs, general partners at the top collect a growing percentage of cash flow as the cash flow increases. So they have an incentive to issue more units (stock) to raise capital to juice cash-flow growth. That’s good for the general partners at the top, but it dilutes regular shareholders at the bottom of the structure who buy units in the open market. Under the C corporation structure, this misalignment of interests is gone.
Six simpler was to reach for yield
First, the Hennessy BP Midstream Fund pays an 8.2% yield and it outperforms competitors over the long term, according to Morningstar. So that’s one place to go to collect yield in the energy infrastructure space.
Otherwise, here are five companies to consider. I’ve suggested many of these in my stock newsletter Brush Up on Stocks in part because of their bullish insider buying. All are former MLPs or C corporations concurrent with an MLP.
They’re still attractive even if they trade slightly above where insiders recently stopped buying. The 2020 estimated yield is the yield you’ll get next year if you buy now and hold, based on expected dividend hikes according to Raymond James analysts.
Kinder Morgan
Current yield: 4.3%
2020 estimated yield: 6.8%
Insider sentiment read: Bullish buying up to $19.50
One of the largest midstream energy companies, Kinder Morgan KMI, +0.75% was originally pieced together by industry ace Rich Kinder from Enron’s midstream assets in the late 1990s. Its big presence in natural gas pipelines makes it a play on LNG exports, which should take off over the next five to 10 years.
Oneok
Current yield: 5.3%
2020 estimated yield: 5.6%
Insider sentiment read: Bullish buying up to $67.60
Oneok’s OKE, +0.91% natural gas and natural gas liquids pipelines deliver energy to the Gulf Coast from the Rockies, Texas and the mid-continental U.S. About 90% of the company’s earnings are fee-based, which limits commodity price exposure, says Morningstar’s Stephen Ellis.
Williams Companies
Current yield: 5%
2020 estimated yield: 6.3%
Insider sentiment read: Bullish buying up to $26
Williams’ WMB, -0.63% Transco pipeline connects natural gas producers in the Marcellus and Utica fields in the Northeast to southern utilities and processing plants along the Gulf Coast. This makes it a play on the LNG export business. It also has pipelines in the Northwest serving Washington.
Targa Resources
Current yield: 8.3%
2020 estimated yield: 9%
Insider sentiment read: Bullish buying up to $47
Targa Resources TRGP, +1.53% handles natural gas gathering and processing in the nation’s most productive energy fields in the Permian Basin, but it also serves the Bakken, Stack and Scoop shale plays in North Dakota and Oklahoma.
Plains All American Pipeline
Current yield: 5.2%
2020 estimated yield: 7.7%
Insider sentiment read: Bullish buying up to $23.40
Plains All American PAGP, +1.06% handles energy processing, storage and transportation throughout the U.S. and Canada. But it, too, has significant exposure to the high-growth Permian Basin region.
The bottom line: If, like me, you’ve avoided MLPs because of all the headaches, you no longer have that excuse. Yes, these companies are still boring. But if you are in investing for the entertainment value of the businesses you own, you probably shouldn’t put money in stocks.
