Master limited partnerships can be exceptional passive income producers.
Investing in companies that pay dividends can enable anyone to start collecting passive income. The average stock currently yields around 1.4% (as measured by the S&P 500's dividend yield). That implies that a $1,000 investment in the average dividend stock would produce about $14 in annual dividend income.
Many companies offer even higher dividend yields. In particular, energy master limited partnerships (MLPs) currently produce prodigious income streams, with many top ones yielding 7%-8% (suggesting they could generate $70+ in annual passive income). Here's a closer look at these passive-income vehicles and some of the best MLPs for passive income.
What is an MLP?
A master limited partnership is a publicly traded limited partnership. They provide investors with the tax advantages of limited partnerships and the liquidity of a publicly traded company.
Limited partnerships are pass-through entities that pass income, losses, credits, and deductions through to limited partners who report them on their taxes. As a result, MLPs don't pay tax at the corporate level, eliminating the potential for double taxation. Limited partners can often defer paying taxes on their MLP distributions until they sell their units.
However, there are some tax complications. MLPs send their investors a Schedule K-1 to help them file their taxes. These forms typically arrive later in the tax season than a 1099-DIV form, which can delay your tax filing. Further, K-1s can make filing your taxes more complicated, potentially requiring that you hire an accountant.
Those issues aside, the lucrative tax-advantaged passive income can make investing in MLPs well worth the additional tax headaches.
3 top MLPs for a prodigious passive income stream
There are currently nearly 100 MLPs. Three of the top ones are:
- Energy Transfer (ET 0.71%): 8% current distribution yield
- Enterprise Products Partners (EPD 0.21%): 7.2% current distribution yield
- MPLX (MPLX -0.10%): 8.2% current distribution yield
All three MLPs generate relatively stable cash flow by operating pipelines and other energy infrastructure assets. They get paid fees as oil, natural gas, and other commodities flow through their pipelines, processing plants, storage terminals, and export facilities.
Energy Transfer generated enough cash to cover its 8%-yielding distribution by about 1.9x last year. That was a little higher than Enterprise Products Partners (1.7x) and MPLX (1.6x).
However, those MLPs have lower leverage ratios (3x for Enterprise Products Partners, 3.3x for MPLX, and around 4x for Energy Transfer). Overall, the MLPs have very solid financial profiles, giving them the flexibility to pay their generous distributions while continuing to invest in growing their operations.
All three MLPs reinvest a meaningful portion of their retained cash flow into high-return organic expansion projects. Energy Transfer expects to fund $2.4 billion-$2.6 billion of growth capital projects this year, while Enterprise Products Partners anticipates investing $3.25 billion-$3.75 billion, and MPLX sees growth spending coming in around $950 million.
In addition, they'll make accretive acquisitions when the right opportunities arise. Energy Transfer bought fellow MLP Crestwood Equity Partners in a $7.1 billion deal last year and acquired Lotus Midstream for about $1.5 billion. Meanwhile, MPLX bought a partner's interest in a joint venture (JV) for $270 million last year while enhancing another JV earlier this year. Finally, Enterprise Products Partners spent $400 million to acquire JV interests a couple of months ago.
Those growth-focused investments should give these MLPs the fuel to continue increasing their distributions. Energy Transfer just raised its payout again this week and has increased it by 3.3% over the past year (within its 3%-5% annual target range). Meanwhile, Enterprise Products Partners boosted its payout by 3.3% in January and has increased it by 5.1% over the past year. MPLX's latest increase came in October, when it gave investors a 10% raise, its second straight year of delivering 10% distribution growth.
Big-time passive-income streams
MLPs stand out for their ability to produce passive income and offer higher-yielding payouts that are largely tax-deferred. Investors have lots of options, led by Energy Transfer, Enterprise Products Partners, and MPLX. They offer yields in the range of 7%-8% backed by rock-solid financial metrics, which gives them the flexibility to invest in growing their operations. As a result, these MLPs should produce attractive and growing cash distributions, making them ideal options for those seeking to supercharge their passive income.
Matt DiLallo has positions in Energy Transfer and Enterprise Products Partners. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
