If you’re a dividend-seeking investor, you’ve probably heard about MLPs.
But, if you’re like many investors, you may not really know what MLPs are, or how to make money investing in them. I’m here to help guide you.
MLPs are Master Limited Partnerships. They’re publically traded companies, usually focused in energy infrastructure, like oil and gas transport or storage.
As tax-exempt entities, MLPs pass on practically all their income to shareholders, in the form of distributions (which can be thought of as dividends.) As a result, MLPs can pay out huge yields, making them potentially great investments.
But, not all MLPs are created equal. Some lure in investors with high, but unsustainable yields. Because MLPs pass on most of their income to unitholders (investors), a bad quarter or year can mean huge cuts to the company’s payout, causing yields to fall and shares to plummet.
When picking an investment-worthy MLP, you want to find one that has a growing business with a strong history of distribution increases.
I’ve found a rock-solid MLP that has maintained or increased its quarterly distribution every quarter since going public, in 2007. At its current price, this MLP carries an outstanding forward annual dividend yield of 7.7% for a projected forward annual distribution of $2.38 per share. Growing, through acquisitions, this MLP looks able to reward investors well into the future.
This enticing MLP is Legacy Reserves (Nasdaq: LGCY). A Texas-based limited partnership, Legacy specializes in the exploration, acquisition and development of oil and natural gas reserves. Its properties are primarily located in the resource-rich areas of the Permian Basin, Mid-Continent and Rocky Mountain regions of the U.S.
The partnership’s primary business objective is to increase quarterly cash distributions for you, the investor. It does so by generating stable cash flow through developing and acquiring mature oil and natural gas properties, with known production rates, that generate predictable cash flow.
Since 2006, the company has spent $1.6 billion to successfully make more than 120 oil and natural gas acquisitions. Over this time, quarterly distributions have increased 44%!
While Legacy has a strong acquisition history, perhaps one of its most important developments, to date, is the recently announced strategic alliance with Wyoming’s WXP Energy (NYSE: WXP).
In this alliance, Legacy is spending $355 million in cash, and another $350 in Incentive Distribution Units, to acquire 276 billion cubic feet of proven reserves from WXP Energy. These reserves are comprised of 83% natural gas.
In the first year, Legacy will get 29% of initial working interest in the wells. This amount increases to 37% next year and 41% in 2016. Because the wells are natural gas rich, and have a stable production profile, they should be great long-term assets for Legacy.
At present, Legacy is an oil-heavy MLP. Its proved reserves are 63% in oil, 32% in natural gas and 6% in natural gas liquids. With the WXP Energy partnership, Legacy is transforming itself into a more diversified company, essentially balanced between oil and natural gas. With greater prominence in natural gas, the MLP should be better suited to weather any downturns in the oil market; this diversification should, literally, help fuel future distribution increases.
In addition to strategic asset acquisitions, Legacy aims to raise distributions by increasing production volumes at existing properties. At the end of 2013, the MLP increased proved reserves to a record 87.6 MMBoe (million barrels of oil equivalent.) At an average production rate of 19,402 Boe/day, existing reserves should last at least 10 more years. For the full 2014 year, management expects average daily production could increase as much as 1.8% to 19,759 Boe/day. With future production increases, Legacy should continue to be a good long-term investment.
Legacy also passes value on to unitholders by hedging a significant portion of future production with forward pricing contracts. Some of these contracts are negotiated up to 2016. These contracts help limit exposure to volatile commodity prices and protect cash flow. The excess capital is passed on to investors in the form of rising dividends.
Based on price hedging, increasing production capacity, and strategic acquisitions, management’s outlook for the full-year 2014 is solid. Based on strong projected oil and natural gas sales, the MLP expects upcoming full-year revenue to increase 18.3% to $574.4 million from $485.5 million in the comparable year-earlier period.
Net income is projected to turn-around from a loss, bringing earnings per share from -$0.59 per unit to +$0.98 per unit. The recent partnership with WXP Energy should raise Legacy’s production capabilities, contributing to both immediate and long-term financial growth. Remember, when MLPs increase profits it also means increasing quarterly distributions to unitholders.
In addition to a strong growth outlook, the stock chart appears very strong. Shares recently broke out of a long-term consolidation pattern and are now blasting ahead. Between August 2013 and May 2014, the stock was stuck in a narrow trading range between about $24 and $27.50. Now, however, shares have formed a strong uptrend; they show no sign of slowing down.
Given the bullish technical and fundamental outlook, I plan to go long on the oil and gas MLP.
Risks to Consider: Innovative drilling practices, including horizontal drilling and fracking techniques are making it possible to access oil reserves more easily and cheaply. As a result, future supply could increase. With high supply, prices could drop if demand falls. Legacy directly benefits from rising crude prices. However, because the company is becoming an increasingly diversified natural gas play, the MLP should continue to perform well. Price hedging and strategic acquisitions should further drive growth well into the future.
Action to Take --> Buy LGCY at market open. Set initial target at $36.99 for a potential 17.7% return by 2015. Set a stop-loss at $27.58.
