(09/03/13) Kinder Morgan: Growth Engine and Yield

Classifying MLPs as income stocks is a big mistake. Yes, the partnerships toss off tons of cash. But they're more like growth stocks in disguise, asserts Robert Hsu, contributing editor of Money Morning.

Remember, the high income is merely a function of the MLP structure. They're set up in a pass-through structure. This means they must pass on the vast majority of profits to their investors.

And, up to 90%, or more, of the distributions you receive from an MLP will be considered a return of capital, not income, by the IRS. You don't pay taxes immediately on this portion of the distribution. But these big cash payouts are driven by growth. A lot of it.

MLPs are limited partnerships that are easy to own, with most of them trading on the New York Stock Exchange. And, as I just showed you, MLPs have attractive yields—easily surpassing 5% and even reaching double-digits.

What's more, MLPs combine the tax benefits of limited partnerships, along with the liquidity of stocks. You can enjoy tax savings not available to ordinary dividend stocks.

Most MLPs are in energy-related industries. The energy MLPs I like are in the exploration and pipeline industries not affected greatly by the price swings of the underlying energy commodity, such as oil and natural gas. Price swings are kept in check because energy transportation and pipeline rates are often set by regulatory agencies.

When I am looking for MLPs to buy, I look for companies engaged in stable businesses that also have a strong distribution payout track record.

Proven management is also a key ingredient, but perhaps the most attractive feature of an MLP is its yield. Here I like the yield to be well north of 5%.

The MLP I really like is Kinder Morgan Energy Partners, L.P. (KMP), which is part of the Kinder Morgan companies, the largest midstream energy outfit in North America.

The MLP operates one of the largest oil and natural gas pipeline networks in the US. It's run by one of the top pipeline pioneers in the country, Richard Kinder.

And it directly benefits from the fracking revolution that has enabled the US to produce more oil and natural gas than ever before, a trend likely to continue for decades.

All that energy has to be distributed, which means there will be an increasing demand for transportation and pipelines—precisely what KMP provides.

KMP has steadily increased its quarterly distribution by over 30% during the past five years, and those increasing distributions have come, despite an approximate 75% drop in natural gas prices over the same period. This is where you see the benefit of price stability in this type of energy MLP.

Of course, the biggest reason to like KMP is all the cash it produces. The partnership's current quarterly distribution is $1.32 per unit, creating a yield of 6.45%.

If history is any guide, it has a chance to double in value in the next five years. Now that can make you rich.