MLP Defined

A MLP is a master limited partnership. MLPs are publicly traded limited partnerships and operate in the natural resource, financial services, and real estate industries. MLPs have a significant tax advantage over other public companies; MLPs are not subject to the double taxation of public corporations. Instead they pass through the income, meaning owners of MLPs are personally responsible for paying taxes on their individual unit of the MLP’s income, gains, losses, and deductions.

Evaluating an MLP

Since MLPs are required to pay out their income to unit holders the size and visibility of future cash distributions are the largest contributing factor in the value of MLP units. Consequently, it is particularly important for investors to evaluate whether an MLP is able to meet its current distribution obligations and whether it will be able to continue or raise its future distributions. To judge this the distributable cash flow coverage ratio of used.

Cash Flow Coverage Ratio = (Net Income + Depreciation, Amortization & Other non-cash expenses - maintenance Capital Expenditure) / Total Distributions

The ratio measures compares total distributable cash flow to the amount paid out to shareholders. If the ratio is below 1.0 the firm is not generating enough cash to cover its distributions.

The Screen

When searching for MLPs it is very difficult to screen for high cash flow coverage ratios directly. Each MLP will have different portions of their Capital Expenditures geared towards maintenance of continuing operations – you will need to examine the note in their 10k.

However, the ability of a MLP to maintain and grow their distributions will be factored into the MLP’s stock price via its standard deviation and dividend yield. In theory, more unsecured distributions will correlate with a higher standard deviation, and the dividend yield will likely be higher to compensate for this risk.

I have prepared a screen of the 10 lowest yield standard deviation MLPs and highlighted this with their dividend yield and past one year return (excluding the dividend yield).

The screened MLPs represent low risk and adequate yielding investment options within the MLP space.