If 2019 was the year of the real estate investment trust (REIT), 2020 will be the year of the master limited partnership (MLP).
Both REITs and MLPs are great alternatives for investors seeking income.
But there are key differences that distinguish the two. And one big difference will be front and center next year.
REITs typically own real estate or bundles of financial instruments like mortgage securities. Both generate cash flows.
By law, these cash flows are distributed back to shareholders.
The corporate structure of the REIT is similar to other stocks, where the management teams owe a fiduciary responsibility to shareholders.
But in a master limited partnership, investors buy units of the partnership.
There is no “corporate structure” like there is with REITs
Because an MLP owns an underlying commodity, most are in the energy sector.
That reliance, and ownership of a commodity, results in far more volatility for the MLP owner. But it can also lead to a higher reward when prices are moving higher.
REITs are much more leveraged than the typical MLP.
This use of leverage, especially in a low-interest-rate environment like today, helps fuel turbo-charged distributions, some well above 10%.
The advantage goes to the MLP when interest rates are going higher and the underlying commodity price of the MLP appreciates.
And that is exactly the environment we’re likely to see in 2020.
Monetary easing policies are becoming more popular around the world, propelling economic growth.
A leading indicator of inflation, copper prices, has been moving higher over the last month as well.
That bodes quite well for oil prices and owners of MLPs going forward.
These are the top three MLPs to keep on your radar for 2020…
Top MLPs to Watch in 2020, No. 3
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One measure of MLP financial health is distribution coverage. Comparing an MLP’s distributable cash flow generated in a period to the total cash distributions paid for that period shows us whether or not the dividend yield will likely be cut.
If the distribution coverage goes below 1, it’s highly likely that the dividend will be lowered. No sense buying a high-dividend MLP if that yield is in danger.
At the moment, Plains All American Pipeline LP (NYSE: PAA) pays a dividend of 8.16%. Even better is the distribution coverage of 2, which suggests this dividend is secure.
Analysts do expect profits at Plains All American to fall in 2020, but investors need not be concerned given the strong distribution coverage.
With rising oil prices, the distribution coverage is likely to go even higher.
Top MLPs to Watch in 2020, No. 2
The midstream energy sector is going to do very well in 2020. If oil prices do indeed move higher, margins for refineries and pipelines will go up. Structured as an MLP, that excess cash flow will be distributed to unit owners.
One of my favorite midstream energy companies is Magellan Midstream Partners LP (NYSE: MMP). Magellan pays a dividend yield of 6.53%.
Analysts expect Magellan to make $4.40 per share in 2019 growing to $4.68 per share in 2020. That may not be huge growth, but Magellan is meant to be owned for cash flow today.
In that regard - and with the odds of even higher cash flows in an inflationary environment in 2020 - Magellan is a dividend stock to own heading into next year.
Top MLPs to Watch in 2020, No. 1
What if we can find an MLP paying a rich dividend that also offers profit growth and potential stock appreciation? That would be the holy grail for income investors.
That’s exactly what investors have with Hess Midstream Partners LP (NYSE: HESM). The oil storage and transport company pays a healthy dividend of 7.85%.
The company is growing earnings too.
Analysts expect Hess to increase profits by 20% in 2020, a number that is likely to be even stronger should oil prices go higher.
At current prices, shares of Hess trade for only 15 times current-year estimated earnings.
Add it all up, and Hess is a must-own stock for 2020. Big dividend combined with strong earnings growth and a low valuation will likely result in returns of 20% or more in the coming year.
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