Master Limited Partnerships for Income (Barrons)

SATURDAY, JUNE 2, 2012 Pipelines to Profits
By ANDREW BARY

The allure of master limited partnerships gets stronger, based on robust operating profits, tax breaks and a booming U.S. energy sector.


Master limited partnerships have been one of the best investments in the past 10 years, generating an annualized total return close to 16%, versus just 4% to 5% for the Dow industrials and the Standard & Poor's 500.

While these historical returns are excellent, the $250 billion sector has come under pressure, with the benchmark Alerian MLP Index down 9% this year. The yield stands at 6.6%.

MLPs mainly transport and store oil, natural gas, natural-gas liquids, gasoline, and other refined petroleum products. An estimated 65% of the industry's revenue comes from fees, many based on government-regulated rates. MLPs therefore offer some of the stability of electric utilities, plus growth potential tied to the construction of pipelines, plus storage and other facilities, driven by booming U.S. energy output.

MLPs are as attractive as they have been in some time," says Charles Lieberman, chief investment officer of Advisors Capital Management in Hasbrouck Heights, N.J. "Their investment opportunities are unparalleled as they expand their pipeline systems to provide access to new energy fields."

Comments Credit Suisse analyst John Edwards: "We conservatively see mid-single-digit annual growth in distributions over the next several years. Combine that with a mid-6% yield, and that looks pretty attractive, given current market conditions." Edwards says the yield gap between MLPs and the 10-year Treasury note is historically high at five percentage points, versus an average of 3.3 since 1999. That gap is skewed by the ultra-low yield of 1.5% on the Treasury, but MLPs stack up well against other yield-oriented groups, such as real-estate investment trusts and electric utilities, which yield in the 3% to 5% range.

MLPs historically have done very well when the yield gap has been around five percentage points. Edwards sees a total return exceeding 15% for MLPs over the next year.

Probably the biggest negative for MLPs is that they pay out nearly all of their cash flow in distributions, making them rely on the sometimes fickle capital markets to fund projects. This also makes the distributions vulnerable to setbacks. A drop this year in prices for oil and natural-gas liquids has hurt the sector.


Edwards favors large, well-capitalized MLPs like Enterprise Products Partners, Kinder Morgan Energy Partners, and Plains All American Pipeline, with yields in the 5% to 6% area. Lieberman is partial to higher yielders like Regency Energy Partners and Energy Transfer Partners that yield around 8%. Among high-yielding MLPs, Edwards likes Boardwalk Pipeline Partners, now at 8.2%.

MLP dividends technically are distributions, and more than 80% of the industry's payouts are tax-deferred. The taxed portion is treated as ordinary income, because master limited partnerships aren't subject to corporate taxes. The dividend's tax-deferred portion cuts investors' cost basis in MLP units (aka shares) and is subject to taxes when the units are sold, says New York tax expert Robert Willens. Many investors avoid these taxes if they hold the units until death and their estates are below the current $5 million inheritance-tax threshold.

Another minus is that investors get annual K-1 tax forms, rather than 1099s. This can result in more cumbersome and costly tax filings. The tax issue has helped spur the growth of exchange-traded funds and notes that do away with dreaded K-1s. Alerian MLP (AMLP) is the largest ETF and trades around 16, producing a yield of 6%. The drawback here is that appreciation in MLP holdings is subject to corporate taxes, dampening the upside.

The JPMorgan Alerian MLP, the largest exchange-traded note, is around $36 with a 6% yield. It offers a return linked to an Alerian index of 50 MLPs. A plus is no corporate taxation. A negative is that the shares amount to a debt obligation of JPMorgan Chase, exposing investors to credit risk, albeit limited, given the bank's strength. And the dividends are subject to ordinary income taxes. ETNs are good for investors who want MLP exposure in tax-deferred accounts like IRAs and 401(k)s. Direct MLP investing in these accounts can subject holders to certain taxes.


Big Gap, Big Opportunity
MLPs yield an average of 6.6%, five percentage points more than 10-year Treasuries. Historically, they've done well when the gap is that wide.

Enterprise Products Partners, at $48, is the largest MLP, and has good growth potential thanks to $7 billion of capital projects. Its yield is a below-average 5.1%, balanced by its growth outlook, a higher-than-average distribution-coverage ratio and distribution increases in 31 straight quarters. Edwards has an Outperform rating and a $59 price target. One plus is that Enterprise doesn't share profits with a general partner, unlike many MLPs, because it bought out its GP in 2010.

KINDER MORGAN ENERGY Partners (ticker: KMP) is big, diversified, and well-managed, with the country's largest natural-gas transportation system. But it allocates 45% of its cash flow to Kinder Morgan (KMI), its GP—one of the industry's highest GP takes.

Kinder Morgan Energy Partners trades at $78 and yields 6.3%, based on an anticipated 2012 distribution of $4.98 per unit. Its sister company, Kinder Morgan Management (KMR), is economically equivalent, but is structured as a corporation and pays the same dividend amount in stock, not cash. KMR, at $72, yields 6.9% and has traded at a persistent discount to KMP. Credit Suisse's Edwards has a $92 price target.

Plains All American, a leading oil transporter, has significant exposure to rising crude production in mid-America. "It's in the sweet spot for the infrastructure build-out theme," says Kyri Loupis, portfolio manager for MLP strategies at Goldman Sachs' investment-management division. Plains, now at 78, has a 5.3% yield. Loupis sees its distributions rising 8% annually over the next three years. He also likes MarkWest Energy Partners (MWE), which trades at 46 with a 6.3% dividend yield, because of its exposure to fast-growing energy production in the Marcellus shale in the Northeast.


Some MLPs, and an exchange-traded fund and note that invest in the sector:

Company/Ticker Recent Price 52-Wk Change 2012E Cash Flow* Price/ Cash Flow Div Yid Stk-Mkt Val (bil)
Boardwalk Pipeline Partners /BWP $25.95 -10.8% $2.11 12.3 8.2% $5.4
Energy Trans Part /ETP 43.39 -8.7 3.78 11.5 8.2 10.2
Enterprise Prods/EPD 48.76 17.1 3.63 13.4 5.1 43.3
Kinder Morgan Eng /KMP 78.33 5.1 5.19 15.1 6.1 26.2
Kinder Morgan Mgt /KMR 71.03 8.8 5.19 13.7 7.0 7.1
Plains All American /PAA 78.53 26.2 6.33 12.4 5.3 12.7
Regency Energy Part /RGP 21.52 -14.6 2.06 10.4 8.6 3.7
ETF or ETN/Ticker
Alerian MLP ETF /AMLP $15.73 -1.3% N/A N/A 6.2% $3.2
JPMorgan Alerian ETN /AMJ 36.54 -0.5 N/A N/A 5.7 4.1
*Per Share E=Estimate N/A=Not Applicable
Sources:Thomson Reuters; Bloomberg; Credit Suisse; JPMorgan
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.DIMITRA DEFOTIS contributed reporting for this article.

Investing in Master Limited Partnerships (WSJ)

AUGUST 10, 2010 Frenzy in Energy Partnerships
Investors Stick Billions of Dollars Into a Stock-Market Niche Known as MLPs
By TOM LAURICELLA And CAROLYN CUI
Lured by hefty yields, investors are pouring billions of dollars into a small corner of the stock market—energy-focused master limited partnerships—which has seen a huge rally of 15% this year. And that makes some people nervous.

MLPs are mostly companies that own and operate pipelines, primarily for natural gas and oil. Benefiting from the tremendous expansion of energy infrastructure in the U.S., MLPs essentially collect rent from energy producers who use their facilities.


Over the past decade, the Alerian MLP index, the main benchmark for the group, is up about 11% a year. That is a handsome payoff compared with the Standard & Poor's 500-stock index, which is down 2.6% a year. Their major appeal is payouts to investors these days averaging around 7% a year at a time when bond yields are at all-time lows. MLPs are expected to increase those distributions by another five percentage points or so a year.

But the recent surge in popularity of MLPs may be adding a new element of risk to the group. The Alerian index, including distributions, has returned 21% in 2010 without any meaningful change to the sector's fundamental outlook. Instead those gains are seen as being fueled by the rush of new money into the sector. Meanwhile, most MLP funds concentrate their portfolios in a handful of the same stocks. The end result is MLPs could be growing vulnerable to a decline in prices.

"We think the sector is a bit frothy in the short run," said Ethan Bellamy, an analyst at Wunderlich Securities Inc.

The big yields of MLPs are the result of their corporate structure. While they trade like stocks, the companies generally distribute all their profit to shareholders because of their limited partnership status. Better yet, those distributions usually aren't taxable until investors sell the shares.

Another selling point for MLPs is their diversification. They have low levels of correlation to the rest of the stock market and to U.S. Treasurys. In June, for example, when the S&P was down 5.2%, the Alerian index was up 5.6%.
MLPs have changed markedly over the years. In their early days in the late 1980s, the underlying businesses ranged from hotels to basketball's Boston Celtics. But concerns were soon raised that some companies were exploiting MLPs to avoid taxes. Laws were tightened and MLPs are now limited to energy and certain natural-resource companies, mainly pipelines and storage for natural gas and oil.

The proliferation of MLP funds started with the launch in June 2009 of the J.P. Morgan Alerian MLP Index Exchange Traded Note, which has pulled in $1.6 billion. On March 30, SteelPath Advisors, an offshoot of Alerian, opened the doors on three MLP mutual funds that have taken in nearly $300 million.

But the floodgates have really opened in the past two months. Legg Mason's Clearbridge unit and MLP veterans Tortoise Capital Advisors each launched MLP closed-end funds and attracted more than $2 billion from investors. With leverage, the funds will be investing some $2.7 billion. And still more funds are in the works, including an exchange-traded fund.

All this money is pouring into a small space. There are roughly 70 MLPs with a total market value of about $200 billion. Only about three dozen of those names trade actively. And the Alerian benchmark is heavily concentrated; the top five names comprise 41% of the index.

At Tortoise, for example, the firm's new $1.1 billion Tortoise MLP Fund, which hasn't yet disclosed its holdings, will specialize in natural-gas MLPs. But its two other biggest funds already have about 52% of their combined $2 billion in assets in natural-gas MLPs. And many of those names are big holdings in the Alerian index.

"Everybody's buying the same top 10," says Jason Stevens, who follows MLP stocks for Morningstar.

Meanwhile, the performance of MLP stocks has been extremely uniform, suggesting little differentiation by investors among individual MLPs. Among 10 oil-pipeline MLPs tracked by Wunderlich Securities as of Aug. 4, seven are up 29% to 41% in the past year, and another two are up 20% or more.

Jerry Swank, founder of Dallas-based Swank Capital LLC, which manages an MLP portfolio of $1 billion, says he is concerned about "a temporary imbalance between supply and demand" that could potentially reverse into a selloff.

The rally already has pushed down yields. A year ago, MLPs on average yielded 8.8%, but that has dropped to 6.3%, Wunderlich Securities says.
Michael Blum, an MLP analyst at Wells Fargo Securities LLC, figures MLPs are trading at a multiple of 11.8 compared with 12 over the past five years using discounted cash flows, the standard metric for valuing MLPs.

"MLPs look fairly valued," Mr. Blum says.

But valuation concerns mightn't prove a deterrent as investors chase distributions and growth that have yielded far more than other investment options.

"We see the typical MLP increasing its distributions by 5% a year," said Morningstar's Mr. Stevens. "And if you've got securities yielding 6% to 8% … you can lock up a 12% gain."

Supporting that optimism is that MLP clients sign long-term contracts, often for 10 or 15 years. Those contracts often contain clauses that increase the fees paid to MLPs to adjust for inflation.

Still, the longer-term outlook for MLPs isn't risk-free. MLPs increase their distributions one of two ways: They either build or buy new pipelines and storage facilities. Both avenues require tapping the stock or bond markets to pay for their expansion. Any interest-rate increase will result in higher borrowing costs and potentially smaller payouts for investors.

And their tax-deferred appeal could be at risk if Congress revisits their tax status. Says Christopher Eades, a portfolio manager on the Clearbridge Energy MLP Fund: "An investor in MLPs has to watch what's going on in Washington extremely carefully."
Write to Tom Lauricella at tom.lauricella@wsj.com and Carolyn Cui at carolyn.cui@wsj.com

BP and Bankruptcy (NY Times)

June 7, 2010
Imagining the Worst in BP’s Future
By ANDREW ROSS SORKIN

It seems unthinkable, even now, that the disastrous oil spill in the Gulf of Mexico could bring down the mighty BP. But investment bankers get paid to think the unthinkable — and that is just what they are doing.

The idea that BP might one day file for bankruptcy, particularly as part of a merger that would enable it to cordon off its liabilities from the spill, is starting to percolate on Wall Street. Bankers and lawyers are already sizing up potential deals (and counting their potential fees).

Given the plunge in BP’s share price — the company has lost more than a third of its value since Deepwater Horizon blew — some bankers and analysts say BP is starting to look like takeover bait. The question is, who would buy BP, given its enormous potential liabilities?

Shell and Exxon Mobil are both said to be licking their chops. And already, flinty legal minds are dreaming up scenarios in which BP would file a prepackaged bankruptcy and separate the costs of the cleanup — and potentially billions of dollars in legal claims — into a separate corporate entity.

Tony Hayward, BP’s chief executive, has insisted that his giant will weather this storm. BP is indeed a money machine: it turned a profit of nearly $17 billion last year.
“The strength of cash-flow generation in recent quarters has provided us with a balance sheet that allows us to fully take on the responsibility for the Gulf of Mexico response,” Mr. Hayward told employees last Friday.

But that hasn’t stopped the deal crowd from blue-skying potential outcomes. Here is some of the math:

BP’s costs for the cleanup could run as high as $23 billion, according to Credit Suisse. On top of that, BP could face an additional $14 billion in claims from gulf fisherman and the tourism industry. So while conservative estimates put the bill at $15 billion, something approaching $40 billion is not out of the question. After all, little about this spill has turned out as expected.

The company has about $12 billion in cash and short-term investments, but there is already a debate about whether it should cut its dividend out of fear that it could run out of money. Of course, it could sell assets or seek loans, which in this environment is still not that easy.

But all those numbers don’t account for the greatest possible threat: a jury verdict against BP. Such a verdict might push the cost of the spill into the hundreds of billions. If that happened, even BP might buckle.

This outcome might seem far-fetched right now. But on Wall Street bankers have already coined a term for it: “the Texaco scenario.”

In 1987, Texaco was forced to file for Chapter 11 because it could not afford to pay a jury award worth $1 billion to Pennzoil. That award had been knocked down by a judge from a whopping $10.53 billion. (Pennzoil successfully sued Texaco for “jumping” its planned merger with Getty Oil, in part, by moving the case to local court near its headquarters. The jury awarded triple damages.)

Imagine the BP case playing out in a Louisiana courtroom, against the backdrop of an oil-choked local economy, high unemployment and an angry public. How high can you count?

Under the Oil Pollution Act of 1990, BP’s liability for economic devastation — above the cost of the cleanup — is capped at $75 million, a number Mr. Hayward has already said he plans to blow through. But if BP is found to have violated safety regulations, which seems likely, that cap becomes irrelevant.

That’s not to say that BP won’t fight a huge judgment against it. After the Exxon Valdez spill, Exxon fought a $5 billion fine for punitive damages for two decades. It won. The fine was cut down to $4 billion, then to $2.5 billion. The case eventually made it to the Supreme Court, which found that Exxon’s actions were “worse than negligent but less than malicious,” and vacated the fine. The judgment limited punitive damages to the compensatory damages, which were calculated as $507.5 million.

“There are so many imponderables over whether its liabilities would be capped or not,” David Buik of BGC Partners in London wrote of BP. “If BP’s share price continues to fall, it could become a takeover target.”

Given that Shell and Exxon have billions in cash on hand and market values that easily exceed BP — Exxon is twice the size — bankers say now is the time to make a deal, as long as an acquirer can find a way to separate the legal exposure. That, of course, is a big ‘if.’

There are many people — besides BP — who think even discussing the possibility of a bankruptcy or takeover is silly. But looking out a few years, that may be BP’s best, last hope.

“Even with a prepackaged bankruptcy, BP’s brand is permanently tainted,” said Robert Bryce, a senior fellow at the Manhattan Institute and author of “Power Hungry: The Myths of ‘Green’ Energy and the Real Fuels of the Future.” Yes, BP is financially sound now. It is unlikely to go bust near term, he said.

“Instead, BP will spend the coming decades circling the drain, mired in endless litigation, its reputation irreparably damaged, and its finances weakened,” Mr. Bryce said.

That, if you believe the bankers, is the optimistic outcome.


The latest news on mergers and acquisitions can be found at nytimes.com/dealbook.

Master Limited Partnerships for Income (WSJ, AP)

WEEKEND INVESTOR APRIL 10, 2010

Big Yields, Big Risk in the Oil Patch
Master Limited Partnerships Are Luring Investors for Their Yields and Growth Potential, but Can Plunge When Rates Rise
By TOM LAURICELLA
(See Corrections & Amplifications item below.)


Associated Press

Shares of the master limited partnership have risen more than 11% so far this year.
Yield-starved investors are piling into a small corner of the financial markets sporting big payouts: master limited partnerships. But they should tread carefully. While these energy-related plays are seen as having strong prospects, they also are volatile, and have a history of being tripped up by higher interest rates.

Master limited partnerships, or MLPs, are essentially energy companies that own and operate pipelines and storage facilities for natural gas and oil. They generate revenue by essentially collecting fees from energy exploration and production companies that use their properties.
While the securities issued by MLPs are technically stocks and trade on exchanges, MLPs are unlike most other publicly traded companies. Rather than being structured as corporations, they are partnerships, which means they generally pay out all the cash they generate to shareholders as income.
Those yields are central to MLPs' appeal. On average, MLPs are yielding roughly 7% right now, an unusually high level of income in today's market. In contrast, the stocks in the Standard & Poor's 500-stock index generate dividend yields of only 1.9%, on average. Also central to MLPs' appeal: the increasing development of oil and natural-gas infrastructure in the U.S.

Those two factors have helped fuel the main MLP benchmark, the Alerian MLP Index, to a 19.6% annualized gain over the past decade and a 10.8% rise so far this year. The combination of the high yield and big returns has investors pouring money into the sector. The JPMorgan Alerian MLP index exchange-traded note, launched in March 2009, has attracted $1 billion already.

But in the short-term, external factors can make MLP prices volatile. Because of their big yields, "Many people mischaracterize them as a bond replacement, which they are not," says Shawn Rubin, an adviser at Morgan Stanley Smith Barney who has used MLPs for some clients for a decade. "Although they have a yield component, and hopefully a growing yield … the price fluctuations definitely look more like stocks than bonds."

To a large degree MLPs are creatures of Congress's whims and the tax code. As a result, they have changed over the years. In their early days in the late 1980s, the underlying businesses were all over the map, from hotels to the Boston Celtics. MLP laws were soon tightened. Today they are limited to energy firms, mainly pipelines and storage for natural gas, oil and biofuels.


The universe of MLPs remains relatively small, with 69 publicly traded companies today, up from fewer than 30 a decade ago, according to Alerian. MLPs carry a total market capitalization of $150 billion, and just five companies account for more than 40% of the sector's value, according to Alerian's data. By contrast, Exxon Mobil's market value alone is more than $300 billion.

The long-term bullish case for MLPs centers on expectations for a boom in pipeline and storage in the U.S., especially as new natural-gas fields come into production. That in turn could lead to increases in MLP payouts.

But a look at their history shows the short-term damage that can come from rising interest rates. During MLPs' relatively short history—most didn't exist a decade ago—investors have tended to suffer sharp losses when the Federal Reserve began raising rates, as it is expected to do beginning later this year. For example, in late January 2004 the Fed signaled that an interest rate rise was on the way. The Alerian index fell 4% in a little over a week, recovered and then went into a swoon that took it down 12% from its January high. MLPs also sank after the Fed tightened in 1999 and lost 14% for the year.
One reason for their interest-rate sensitivity is that MLPs increase yields by adding assets, either through acquisition or building from scratch. In either case, MLPs must raise funds for their expansion by tapping the stock or bond markets. As a result, higher interest rates can increase their cost of capital. And if higher rates lead to a slowing economy, that in turn could damp their growth.
But over long periods in which the Fed has raised rates, MLPs have generally recovered well. During the two-year tightening cycle of 2004 through 2006, the Fed raised the federal-funds rate to 5.25% from 1% and MLPs gained 48% between May 2004 and July 2006, data compiled by Kayne Anderson show.

Morgan Stanley's Mr. Rubin says that he is stressing yield-paying investments and, as result, in cases where he might normally recommend 5% of a portfolio be in MLPs, today's he is recommending a 10% stake.

"I'm willing to deal with the variation in price," Mr. Rubin says. Given the potential for long-term increases in MLP yields, "I'd use those interest-rate sensitive pullbacks as moments in time to be a buyer."

Corrections & Amplifications

Master limited partnerships pay out cash they generate to shareholders as ordinary income. A previous version of this article incorrectly described their payouts as dividends.

Write to Tom Lauricella at tom.lauricella@wsj.com

Where the Yields Are (Barrons) MLPs, preferreds, dividend stocks

BARRON'S COVER 12/7/09
Even Better Than Bonds

By ANDREW BARY


With bonds fully priced, it may be time to swap into preferred shares, utility stocks and other investments that produce income but offer protection if interest rates rise.




TIRED OF THE PUNY YIELDS ON YOUR BONDS? Worried that interest rates and inflation will rise, clobbering their prices? Now may be the time to start moving into high-yielding stocks, while scaling back fixed-income holdings.

Bonds rode the price roller coaster up as interest rates fell. They could take a scary plunge if rates shoot up.
This means buying utility and telecom stocks, which have lagged behind the overall stock market this year, as well as master limited partnerships focused on the transportation of natural gas and oil-related products. Other alternatives to traditional bonds include bank preferred stock and convertible securities.

In contrast to bond yields, many of which are near multi-decade lows, yields on these alternatives often run in the 5%-to-9% range. The underlying investments also offer the potential for capital gains and rising income to offset inflation. In addition, income from most of these investments now benefits from favorable tax treatment.

Chuck Lieberman, chief investment officer at Advisors Capital Management, a Hasbrouck Heights, N.J., investment advisor, calls this "investing for income with growth. This strategy offers growth of income and principal, in contrast with a fixed-income portfolio." Lieberman is partial to master limited partnerships, high-dividend stocks, preferred shares and convertibles. Another alternative to U.S. bonds is foreign sovereign debt, which offers a hedge against a weakening dollar.

Master limited partnerships could be the past decade's quietest investment success, generating annualized returns of 18%, against 15% for gold and about zilch for the Standard & Poor's 500. While the MLP market has rallied sharply this year, major operators like Kinder Morgan Energy Partners (ticker: KMP), Enterprise Products Partners (EPD) and Boardwalk Pipeline Partners (BWP) still yield 7% to 8% and have good growth prospects.
Bill Gross, the managing director of Pimco, the giant bond manager, wrote recently in his monthly commentary that electric-utility stocks looked attractive. He noted that their dividend yields now exceed those on utility bonds, while offering the added benefit of more favorable tax treatment than bond interest. "Growth in earnings should mimic the U.S. economy as it always has, and importantly, utilities yield 5% to 6%, not 0.01%," Gross wrote, the 0.01% yield referring to the pitifully low yields on money-market funds.

The two major U.S. telecom operators, Verizon Communications (VZ) and AT&T (T), have trailed the S&P this year and their shares yield more than 6%. Preferred stock from Bank of America, Citigroup and Wells Fargo yield 8% to 9%. Those yields are down from the teens at the market's bottom in March, but still look attractive, given the banks' improving balance sheets and a recovering economy.

Many investors view the stock market as a minefield and the bond market as a haven. But at very low yield levels, bonds become dangerous. "If there is a little bit of a bubble somewhere, it's in the bond market," Lieberman says.

The "safest" part of the market, Treasuries, seems to be the most overvalued, and high-grade corporate bonds don't look much better. Treasury yields range from just 0.85% on two-year notes to 4.4% on 30-year bonds, while high-grade corporates generally offer 3% to 5%. Federally backed mortgage securities also look unattractive at 4% yields. These securities are apt to return little or nothing after inflation and taxes.

While investors are apt to have their principal repaid if they hold their bonds until they mature, they will suffer losses if rates rise and they sell prior to maturity. As for investors in bond funds, they typically have no guarantee of getting their money back. And the funds often levy stiff management fees on their holdings.

Vanguard is an exception, but even with the help of low fees, its big mortgage and muni funds don't yield much. Both the $37 billion Vanguard GNMA Fund (VFIIX) and the $26 billion Vanguard Intermediate-Term Tax-Exempt Fund (VWITX) yield about 3%. These funds carry annual expenses of less than one-quarter of a percentage point, roughly a quarter of what their rivals charge. It's tough to justify taking a fee of a percentage point for a fund invested in 3% or 4% securities, but many fund companies do.
Low yields haven't prevented a stampede into bond funds, which have had more than $40 billion in net inflows during each of the past three months from risk-averse investors who have been pulling money from domestic stock funds.

The Treasury and mortgage markets look particularly vulnerable because they are being supported by the Federal Reserve's keeping short rates near zero and by its purchases of these securities. The Fed's $1.25 trillion program to buy mortgage securities is due to end March 31.

Essentially, bond investors are giving cheap money to American business, the Treasury, new home buyers and overleveraged homeowners. The game may end badly for bondholders because rates are apt to rise in 2010 and 2011 from what appear to be artificially low levels.

The municipal market, a favorite of individual investors, looks overpriced for maturities of under 10 years, where yields are under 3%, and fairly priced for long-term maturities, where yields are around 5%. To get yields close to 6%, investors must buy dicier debt like that of California.

Many investors are chasing the junk-bond market, but the 50%-plus returns seen there this year will be unattainable in 2010, because yields have dropped to an average of 8% from 20% at the start of 2009. Yields on money-market funds are at or near zero, effectively resulting in a confiscation of investor money after inflation.

Real-estate investment trusts have attracted yield seekers, too. But REITs, up nearly 50% in the past 12 months, are no longer a bargain. Green Street Advisors, a Newport Beach, Calif., advisory firm, recently termed them "pricey," in part on high valuations based on earnings relative to the S&P 500. Public-market values of real estate also are high compared with those in the private market. REIT dividend yields are averaging just 4%, and fundamentals in many sectors, including apartments and office buildings, look weak. Net operating income could fall in 2010 for the second straight year.

With all that in mind, here's a look at some sectors that do provide decent yield alternatives to traditional bonds:

MASTER LIMITED PARTNERSHIPS: This $100 billion group is dominated by companies like Kinder Morgan, Enterprise Products and Magellan Midstream (MMP), which transport natural gas, jet fuel, heating oil, gasoline and other petroleum products.
Despite generating some of the best returns of any asset class in the past decade, MLPs are unfamiliar to most investors. That ought to change, because MLPs now provide 7%-to-8% dividend yields, and much of that income is tax-deferred. Dividend growth could run in the mid- to-high-single-digit range in the coming years, resulting in total annual returns above 10%. Kinder Morgan, one of the largest pipeline MLPs, recently said it will pay $4.40 in distributions in 2010, up 5% from 2009's level. Its shares, at 56, yield 7.8%, based on the expected 2010 distribution.

"Think of an analogy to toll roads," suggests Lieberman. "Pipelines are expensive to build, but operating costs are relatively low, which means they generate outstanding cash flow that services debt and finances sizable distributions to owners." Pipelines are utility-like because their rates often are set by federal regulators.

Pipeline shares were slammed in late 2008 because of concern about reduced access to the capital markets. MLPs rely on equity and debt financing for expansion, as they typically pay out nearly all their annual cash flow in dividends. The fears about market access didn't materialize and the stocks have come roaring back with the Alerian MLP Index (AMZ) up 65% in 2009 (with dividends included).

For many large master limited partnerships, 70% or more of their dividends -- technically distributions -- are tax-deferred. That's because dividends usually are far greater than reported net income, largely as a result of noncash depreciation expenses.

Let's say an MLP pays a $2 annual dividend, 80% of which is tax-deferred. An investor would owe income taxes on only 40 cents of that dividend (but the 40 cents would be taxed at regular-income rates, not the preferential dividend rate). The other $1.60 wouldn't be taxed and instead would reduce the investor's cost. If the investor paid $25 a share for an MLP, the cost basis would be reduced to $23.40. Taxes would be paid on the $1.60 when the shares are sold.

Many investors -- particularly the elderly -- simply hold MLP shares, with the intention of putting them in their estates. This essentially results in permanent tax deferral and a muni-like income stream, if the investor's estate isn't subject to federal inheritance taxes. Taxes on the sale of a long-held MLP can be high because an investor's cost basis can drop toward zero after many years of dividends.

MLPs are best held in taxable accounts: they can cause tax headaches in IRAs and other tax-deferred accounts. Investors need to know that they will get an annual K-1 tax form, not a standard 1099, and that can complicate annual filings. Another wrinkle: MLPs often share annual income gains with general partners, or GPs, some of which are publicly traded. This can limit dividend increases. Magellan Midstream has an advantage because it has combined its limited and general partners, meaning there is no GP to cut into the income allocated to the limited partners.

Utilities: Because they're seen as defensive, utility stocks have trailed the market. The Dow Jones Utilities Average has risen just 4% this year, versus a 22% gain for the S&P 500. But investors are warming to utilities, which rose 3% last week.

Until recently, the sector has been held back by various factors, including reduced power consumption, that have dampened profits at Midwestern utilities like First Energy (FE) and American Electric Power (AEP) that have a lot of industrial customers. Another negative has been the plunge in natural-gas prices, which has reduced the price advantage that nuclear utilities like Exelon (EXC) had over gas-fired rivals.

Regulated utilities, such as American Electric Power (AEP), Duke Energy (DUK), PG&E (PCG), Consolidated Edison (ED) and Southern Co. (SO), trade around 13 times projected 2009 profits and roughly 12 times estimated 2010 net, a discount to the S&P 500. "This is a safe level of valuation, and a lot of bad news already is discounted," says Hugh Wynne, utility analyst at Sanford Bernstein. Wynne, who notes that utility dividend yields average close to 5%, favors laggards such as Exelon and FirstEnergy, as well as PG&E.

PG&E, at 43, trades for 13 times projected 2010 profits of $3.42 a share. The other big California utility, Edison International (EIX), also looks appealing, trading near 35, or 10 times next year's estimated earnings. Bulls argue that the company's regulated utility business is worth almost as much as the stock price and that investors effectively are paying little for its independent power division, Edison Mission Group, whose profits have been hit by weak power prices.

As an alternative to individual stocks, investors can buy the Utilities Select Sector SPDR (XLU), an ETF that trades around 31 and yields 4.1%. Several closed-end funds focus on utilities. One is Cohen & Steers Select Utility (UTF), which at its recent price near 15 -- an 11% discount to its underlying net asset value -- was yielding 6%.

TELECOM SHARES: Verizon and AT&T have perked up lately, although their slight losses this year leave them way behind the market. The telecom business faces greater challenges than electric utilities because Americans continue to cut the cord to wireline phones, eroding a once-lucrative business. Yet both companies remain financially solid, trade for low valuations, carry juicy dividends around 6% and are strong players in the wireless market. Reflecting its control of the country's top wireless operation, Verizon, at 32, trades for about 13 times projected 2010 profits of $2.45 a share. AT&T, at 28, fetches 11 times estimated 2010 cash earnings of $2.50, which exclude about 25 cents of goodwill amortization from acquisitions.

Other high-yielders among big companies include major drug companies Bristol-Myers Squibb (BMY), Merck (MRK) and Eli Lilly (LLY), as well as cigarette makers like Altria Group (MO) and Lorillard (LO). They yield anywhere from 4% to 7%.
PREFERRED STOCK: This market was hit in 2008 by multiple shocks, including the bankruptcy of preferred issuer Lehman Brothers, the banking industry's troubles and the government's surprise decision against protecting preferred shareholders of Fannie Mae and Freddie Mac, when Uncle Sam effectively seized those mortgage agencies. Fannie and Freddie preferred trade for about five cents on the dollar.

After bottoming in March, preferreds have surged, with most yields dropping to 6% to 9%. "Preferred stock is subject to the same inflation problem as bonds," Lieberman says. "But yields are significantly higher. That provides sufficient compensation...for the lack of inflation protection."

Citigroup's trust preferred securities, like its Series C, yield more than 9%. Bank of America's 7.25% Series J preferred trades around 21, for a yield of 8.60%, and Wells Fargo's 7.50% Series L preferred trades near 900 for an 8% yield. The Wells Fargo issue has a face value of $1,000, as opposed to $25 for most preferreds.

JPMorgan's preferred has lower yields, just under 7%, reflecting Wall Street's favorable view of the bank. Many foreign banks have issued preferreds; Lieberman likes Barclays, whose preferred yields about 8.5%. Among REITs, the largest preferred issuer is Public Storage, owner of self-storage facilities. Its preferred yields more than 7% and looks pretty safe, given the company's solid balance sheet.

There are two types of preferred. Regular preferred is a senior form of equity, while trust preferred is junior debt and is senior to regular preferred. Therefore it is safer, but it generally yields less. The advantage of regular preferred is that its payouts are taxed at the preferential dividend rate of 15%, while trust-preferred dividends are taxed as ordinary income.

CONVERTIBLE SECURITIES: These hybrid securities, which can be converted into common shares under preset conditions, were battered in 2008 by a weak stock market, the junk-bond market's collapse and forced sales by leveraged convertible hedge funds. But convertibles have risen sharply this year, with Putnam and Fidelity convertible mutual funds up 50% to 60%. The catalysts: the sharp rally in the shares of the generally more speculative companies that issue converts and the junk market's big gains..

This makes for slimmer picking than in early 2009, when investors could get 10% to 15% yields on reasonably solid converts. Be forewarned: It's tougher to buy converts than preferred stock because many convertible bonds are traded in an over-the-counter market where bid/offer spreads can be wide for individuals buying $25,000 to $100,000 of the securities. Convertible funds are a better bet for most investors.

For those willing to do their own work, converts can be an attractive lower-risk alternative to common stock, while offering much of common's appreciation potential.

The money-losing airline industry has needed to raise capital and their converts carry lower rates than regular debt. Issuers include USAirways Group, UAL (parent of United Airlines), Continental Airlines and JetBlue Airways.

Chip maker Micron Technology has a 1.875% issue trading around 85, yielding 5% with a hefty conversion premium of 50%.

One way to play Ford is via its Series S convertible preferred stock, which trades around 36. Ford stopped paying dividends on that issue this year, but some investors are betting the reviving auto maker may resume the payout in 2010 and give investors unpaid dividends of more than $1.50 a share. If Ford resumes the $3.25 annual dividend, the yield would be 9%. The car maker must pay the preferred dividend if it wants to resume a common dividend.

In sum, while hardly anything is as cheap or attractive as it was earlier this year, MLPs, utility stocks, preferred and converts offer appealing alternatives to increasingly unattractive bonds.

More on MLPs (from Barrons)

MONDAY, JULY 27, 2009
SPEAKING OF DIVIDENDS



Good Going, Partners
By SHIRLEY A. LAZO



MASTER LIMITED PARTNERSHIPS -- THE SUBJECT of a Barron's Follow-Up -- pass most of their profits along to their unitholders as tax-deferred distributions. MLPs typically invest in energy assets, and their units have taken a beating from the gyrations in oil prices. But they still make money, and four of them energized their dividends last week.

The Big-Board-listed quartet, which sport yields of 7% to 9%, are Sunoco Logistics (ticker: SXL), El Paso Pipeline (EPB), Holly Energy (HEP) and Western Gas (WES).

With 2008 revenue of more than $10 billion, Sunoco is by far the largest of the group. It was created by Sunoco (SUN), the big energy company, when it transferred most of its pipeline, terminal and storage assets to the partnership.

Despite lower crude-oil prices, which pushed second-quarter revenue down 61%, profits at Sunoco Logistics handily beat Wall Street's expectations. As a result, it declared a cash distribution for the second quarter of $1.04 per common partnership unit, 11.2% above the 2008 second quarter's payout and 2.5% over last quarter's $1.015. Yield: 7.42%. The distribution is payable Aug.14 to unitholders of record Aug. 7. The ex-dividend date is Aug. 5. Disbursements have been made since 2002, and this is the 24th increase in the past 25 quarters.

"Our strong second-quarter performance is a combination of stable cash flows in our base business, along with crude-oil-market opportunities resulting from a cantango [meaning futures prices are above spot prices] market structure," said Sunoco Logistics' CEO, Deborah M. Fretz. "Our conservative balance sheet and access to liquidity have us well positioned to further expand our business platform," she added.

Second-quarter net climbed to $66.6 million, or $1.74 per diluted limited-partner unit, 30% above the figure in the corresponding 2008 stretch. Revenue totaled $1.29 billion. Analysts, on average, had been expecting Sunoco to earn $1.49 on $1.17 billion.

The improvement came from more lease acquisitions, increased crude-oil pipeline and storage revenues, and benefits from the November acquisition of the MagTex refined-products pipeline and terminals system, plus significantly lower costs. Distributable cash flow in the quarter surged nearly 25% from the level a year earlier, to $71.8 million. Debt outstanding at June 30 came to $860.3 million.

The units set a 52-week high of 56.60 June 16. ValuEngine thinks that Sunoco "exhibits attractive volatility, momentum and risk" and therefore rates it a Strong Buy. Citigroup recently upgraded the MLP to Buy from Hold and raised its price target to 60. Sunoco's 52-week low is 27.62.


El Paso Pipeline sweetened its dividend to 33 cents per unit, for a 7% yield. That's an increase of 12% from the year-earlier distribution and 1.5% above the 32.5 cents paid in this year's first three months. El Paso has enriched its payout every quarter since its 2007 initial public offering.

The partnership, with 2008 revenue of $141 million, was formed by El Paso (EP) to own and operate natural-gas transportation pipelines and storage assets. The units currently trade around 19, and their 52-week range is 21.80 to 11.72. Goldman Sachs last week upgraded El Paso to its Conviction Buy list with a price target of 22, deeming recent weakness unjustified.

Holly Energy, which was formed by Holly Corp. (HOC) to acquire, own and operate refined-product pipeline and terminal facilities, added a penny to its payout, bringing it to 78.5 cents per unit, for a yield of 8.88%. Holly now has upped its distribution every quarter since becoming a public partnership in July 2004. The units change hands close to their 52-week high of 37.33; their 52-week low is 14.93. Goldman has downgraded Holly to Neutral, citing valuation.

Western Gas gathers, compresses, processes and transports natural gas for its parent, Anadarko Petroleum (APC), and others. It also raised its quarterly cash distribution a penny, to 31 cents per unit. Yielding 7.25%, its units hit a 52-week high of 17.15 Friday -- nearly double their 52-week low of 9.

Solar Cell Companies (from Fortune Magazine)

Solar stocks for a rainy day
The industry has taken a beating in the market lately, but a few standouts may shine in the long run.

By Michael V. Copeland, senior writer
November 4, 2008: 5:14 AM ET

Find this article at:
http://money.cnn.com/2008/11/03/technology/copeland_solar.fortune/index.htm




(Fortune Magazine) -- No one loves Arnold Schwarzenegger more than the solar industry. Kicking off the nation's largest gathering devoted to all things sunny, the California governor won thunderous applause and two standing ovations from the crowd of 20,000 at the San Diego Convention Center. "What's green for the environment can also be green for the economy," he said. "Solar is the future; it's now; it can't be stopped."

For those four days in October, the Solar Power International 2008 convention drew attendees from 70 countries and generated lines stretching out the door for parking, food, and just about everything else. It seemed as if the power of the sun could conquer all. You wouldn't have guessed that just a week before, the financial meltdown had felled sector after sector, including the once-shining solar industry.

It's not that this swelling crowd thinks the macroeconomic troubles the world faces won't affect the solar industry; they know they will. All the leading solar companies have already seen the value of their stocks plummet far more than the 36% the Nasdaq has dropped from the beginning of the year to Oct. 21. The value of the Claymore/MAC global solar energy index (TAN), an ETF comprising global solar stocks, has dropped 56% since it started trading in mid-April.

Given the uncertainty of the economy, some analysts fear that the solar industry's customers could have trouble financing utility-scale solar projects that use lots of modules. Most residential solar installations, which can cost $20,000 to $30,000, require homeowners to borrow, and that money has all but disappeared. Subsidies in Spain, a huge market in recent years, are decreasing, and it is an open question whether countries that have new subsidies coming online, like Italy, Greece, and France, will fill the void.

In contrast to the 1980s - when solar companies got swept away by cheap oil, withdrawn government subsidies, or steep economic downturns - the sense this time is that the industry is here to stay. And not just stay and survive, but stay and flourish. Concern over climate change, combined with falling prices for solar technology, has made this source of carbon-free electricity more attractive than ever. The worldwide market for solar energy roughly doubled last year, to $33 billion, and analysts expect revenues to grow 33% a year for the foreseeable future. What began as a technology championed by tree huggers and pot growers is now a global market that Lux Research, based in New York City, says will reach about $100 billion in sales within the next five years. Germany, Japan, and Spain rank as the top markets for solar power, but other Western European nations are coming on fast, as are China and the U.S. As part of the bailout package, Congress extended the 30% investment tax credits for clean energy, which should give a boost to the American market.

'A real industry'
"Solar has become a real industry," says Marc Porat, a Silicon Valley veteran and chairman of green-building-materials company Serious Materials. Porat was at the conference in San Diego scouting for solar-electricity generating systems for another green project of his. Looking around the hall packed with startups selling everything from tools for manufacturing solar cells to rooftop hardware for mounting equipment to software for analyzing power needs, Porat emphasizes his point. "You can see that all the gaps in the market have been filled by multiple companies," he says. "It's the same with any good entrepreneurial opportunity."

After 30-plus years of steady improvement, solar electric technology is going mainstream. Photovoltaic (PV) panels, which convert sunlight directly into electricity, can increasingly be found on residential rooftops, warehouses, and Wal-Marts. Large-scale photovoltaic solar farms cover huge swaths of land to supply utilities with clean power. Entrepreneurs have also invested in solar thermal farms, where the sun's heat turns liquid into steam to drive a turbine.

Even with state-of-the-art manufacturing methods, PV solar power is still on average twice as expensive to produce as electricity generated by a coal-fired plant. But prices are finally coming down even as efficiency goes up, and some experts think the cost of solar will rival grid power in the next two to three years. In the meantime, government subsidies are bridging the cost gap in many markets. Also, as more nations pass carbon cap-and-trade laws - in the U.S. both Senators McCain and Obama support the idea - natural gas and coal will become more expensive, which should close the gap further. Finally, the industry has achieved scale. These are not backyard enterprises - they pull in hundreds of millions in revenue annually and do business everywhere on the planet. That they all are pursuing economies of scale should help drive down the cost of solar even further.

Although the industry is able to sell solar cells and modules today as fast as it can make them, analysts predict capacity will almost double in 2009. That has caused some analysts to raise the specter of over-supply and the possibility of a bloody price war among manufacturers. "It's going to trigger a shakeout," says Ted Sullivan, a senior analyst with Lux. "The weakest players will either get acquired or fail."

While industry players mostly disagree with Sullivan on the inevitability of aggressive price wars, they do see an upcoming shift in the industry. "I think we all agree that markets tend to consolidate during times like these," says Tom Werner, CEO of SunPower, a maker of solar-power-generating systems. "This is one of those periods in an industry where a handful of big players emerge."

Of the 14 pure-play public solar companies, experts expect at least three to stand out from the crowd. The winners possess differentiated technology, enough cash to survive, and the financial heft to enter the entire solar food chain, from producing modules to selling power like any other utility. While the industry is likely to remain volatile for some time to come, long-term investors might want to consider stocks of these three companies, whose values now look attractive.

First Solar
Among the favorites of stock analysts is First Solar (FSLR). Founded in 1999 and originally backed by the investing arm of the Walton (Wal-Mart) family, First Solar went public in 2006, right at the beginning of a wave of solar IPOs. In the coming shakeout First Solar should thrive, because with its cutting-edge thin-film technology it is able to produce solar modules more cheaply per watt than its competitors. Traditional crystalline-silicon photovoltaic systems sandwich wafers of silicon between glass, resulting in those boxy panels you see on rooftops. By contrast, First Solar's thin-film technology applies a fine layer of material directly to a glass substrate. The process is faster, and because it requires just a fraction of the expensive silicon used in traditional PVs, it's vastly cheaper. First Solar, which operates factories in Ohio, Malaysia, and Germany, can produce systems for $1.14 per watt of power, compared with $2.90 per watt for traditional crystalline-silicon solar cells. With subsidies, First Solar's products can compete in many parts of the world with a natural gas or coal-fired power plant.

Run by managers who are fanatics about meeting goals and avoiding unnecessary costs, First Solar routinely blows away both its own and the Street's targets. Its manufacturing team is legendary, bringing online factories that exceed expectations. "They come in at over 100% of projected capacity," says Jenny Chase, a senior analyst with New Energy Finance. "No one else does that."

The shares of this highflying Tempe, Ariz., company peaked at $317 in May and now are trading at $144. Analysts expect sales this year to reach $1.2 billion, up 138% from 2007, and to top $2.1 billion next year, with earnings per share more than doubling. First Solar also sits on $633 million in cash. While the stock is pricey with a current P/E of 50 and a forward P/E of 21, the company's growth prospects and strong balance sheet make it look like a buy.

SunPower
While First Solar has laid claim to the lowest price per watt for its modules, SunPower (SPWRA) claims the most efficient. Inch for inch, its modules produce the most electricity. While SunPower's systems are expensive, you need fewer of them, which makes them perfect for homes and businesses where space is tight. The company, based in San Jose, was spun out of Cypress Semiconductor in 2005 and now sports a $4.2 billion market cap - about eight times the size of its former parent. It has carved out a place in the solar industry similar to Apple's in the computer world, producing well-designed, aesthetically pleasing modules. SunPower has distinguished itself in the market as one of the highest-quality makers of modules. "Brand actually does matter in this industry," New Energy's Chase says, "and SunPower has it."

Besides making and installing systems, SunPower has started on a new track. Much like a utility, it has decided to sell the power its modules produce directly to customers. But that new strategy hasn't kept the stock from getting hammered. Over the past year, SunPower stock fell from a 52-week high of $164 to a low of $37 in early October. Werner is shocked by the drubbing his stock has taken. "The markets are valuing growth companies as if they were lead-pencil companies," he says. "This will take care of itself in time, and we are obviously in a really, really unique time."

Now trading at around $54, with a current P/E of 60 and a forward P/E of 12, this stock, too, looks like a buy. Analysts expect SunPower's sales this year to hit $1.4 billion, up 80% from 2007, and to rise to $2 billion in 2009. Earnings per share are expected to rise from $2.33 in 2008 to $3.55 in 2009, a 52% increase.

Suntech Power
While SunPower is obsessed with quality, what solarmaker Suntech Power (STP) offers is scale. Based in Wuxi, China, the company is the world's largest manufacturer of solar PV modules and has set in place an aggressive plan to stay on top, says Roger Efird, who runs Suntech's business in the Americas. With a cash hoard of $752 million, access to cheap local labor, and deep-pocketed Chinese lenders backing it up, the company has been able to take advantage of the fast-growing market. Efird, who is also chairman of the U.S. Solar Energy Industry Association, believes the risk of price declines in solar modules next year will be offset by continued thirst for new sources of clean energy in both China and the U.S.

Wedged in by people filling Suntech's booth at the San Diego solar conference, Efird looks around the hall. "There's not a person in this room who has a module for sale between now and the end of the year. It's all sold out," he says. "What people forget is that there are hundreds upon hundreds of solar projects, in the U.S. in particular, sitting on the shelf waiting for the right economic moment." Efird believes that moment is coming next year.

To hedge its bets, Suntech, like its competitor SunPower, is moving up the food chain, selling power directly to commercial customers. That's not Suntech's only hedge. The company has invested tens of millions to lock in the price of silicon over the next five to ten years, betting that demand will rise and prices eventually will trend up. Competing manufacturers without Suntech's resources will have to face the vagaries of the spot market for silicon in years to come. Of course, if silicon prices drop - new capacity is coming onstream - the move could prove a costly mistake for Suntech.

Suntech's share price has fallen from a 52-week high of $90 in January to $18 in mid-October. It looks cheap, with a current P/E of 17 and a forward P/E of 9. This year's sales, stemming mostly from its business in Asia, are estimated to clock in at $2.1 billion, up 62% over 2007, rising to $3.2 billion in 2009, as it pushes hard in the U.S. Earnings per share are projected to go from $1.67 this year to $2.50 next.

The shares of even the best solar companies have fallen on hard times. Yet for anyone who believes that the world is destined to move away from a carbon-based economy, investing in this nascent industry, at least in the long term, may very well be a move you won't regret.