Discussion of what has changed in the MLP space.

music selection:

weigh-in:  195.6 (1.2)

At the Raptor, I educate the public on how to run an income centric portfolio that has the potential to beat the market with lowered volatility and allow for a greater than 4% withdrawal rate in retirement.  Central to this strategy is a mix of selling options for income, fixed income investing, and high yield investing such as in the REIT, BDC, and MLP spaces.  Today, I want to dig into the MLP space as the industry is in transition.

A Master Limited Partnership (MLP) is a company, usually engaged in some type of natural resource exploitation that has a tax exempt status if it distributions the vast majority of its operating cash flow to unit holders.  This exemption was carved out by congress to encourage the financing of natural resource infrastructure.  Firms set up the structure with general and limited partners.  The limited partner is the tax exempt entity and it often pays an Incentive Distribution Right (IDR) to the general partner.  This is a payment that grows as the distribution grows and serves as incentive for the general partner to grow the income stream of the limited partners.

Over time, these IDRs become punitive.  Several MLPs, have eliminated them recently.  And quite a few have decided they are better off without their tax exempt status altogether and have had the general partner buy out the limited partners to operate as a conventional C corp.  This has the added benefit of improving the credit profile of the company, thus lowering borrowing costs.  Cost of debt is often the largest expense for these companies so it can turn out that after reducing this and eliminating IDRs, the company can distribute more cash flow to shareholders even with the added tax burden.

I want to point out the opportunity in one of the best in class pipeline companies, Kinder Morgan (KMI).  KMI has eliminated its MLP limited partners and taken substantially all assets under the wing of the general partner.  The company has been shoring up its balance sheet and is transitioning into a mode of growing organically instead of through acquisition.  Distributions are expected to grow at 10% or greater per year for several years.

There is a bang up opportunity for income centric investors to earn a good yield to be paid to wait on capital appreciation.  I am going to add in a layer of covered call options writing to juice this income even further.  The result is a high yield bond like return that has good capital appreciation opportunities.

KMI can be purchased today for about 17.50 a share.  The underlying 80 cent distribution yields about 4.5% at that entry price.  The share price and distribution can be expected to grow at 10% or greater for the foreseeable future.  Returns can be enhanced by selling an out of the money covered call such as KMI181116C00019000.  Ravenous Lizards playing the home game could expect 9 cents per share for selling this call.  This would result in an immediate additional yield of 5.68%, bringing the total yield to over 10%.  This is a good rate to be paid to wait for capital appreciation.  Note that in the unlikely event shares are called away at 19 in 33 days, the annualized yield jumps to 97.74%.  This is fair compensation for potentially giving up additional upside in the stock.

Strategies like this allowed me to retire early at the age of 40 on a withdrawal rate of almost 10%.  Portfolio growth, driven by producing income rather than capital gains, since that time has allowed me to get my withdrawal rate well under 6%.  I feel 6% is a good sustainable target for income investors to retire early and expect to stay ahead of inflation.  Market downturns matter little with this kind of investing.  My 12 month projected dividends, distribution, and interest income comes to 118.34% of my budget.  This type of investing ensures you will never have to “sell low” during a market downturn.  You are being paid by the markets to be a patient predator.

A little housekeeping, I was assigned shares of ABBV over the weekend at 94.  I am happy with this outcome as ABBV is a fine company with great future earning prospects and fat option premiums that I can use to extract income while I wait for price recovery.  To that end, I sold ABBV181123C00095000 for 1.90 a share.  Against my cost basis of 94, the trade has an expected annualized return of 18.44% over 40 days.  This is an excellent income rate that further supports my need for income (my options income covers my budget by an approximate 150% above and beyond my passive income).  I will put it out there that if shares rally to my strike of 95, the additional dollar of short term capital gains will bring my annualized return to 28.15%.  A lizard can’t complain with returns like that.  It is also worth mentioning that even though the position moved against me and resulted in assignment, I am up 2.33% on the position to date after accounting for all options premiums earned.  I remain eligible for the underlying 4.23% dividend yield.  This leaves me a happy lizard.

Devour your prey raptors!


The Income Opportunity with Pipelines

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