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Let's Get Paid No Matter How Low Oil Goes
The Income Tripler
Monday, December 29, 2008
By Louis Basenese
Email – #3
** Let’s Get Paid No Matter How Low Oil Goes
In late June, with oil above $130, I told subscribers to The Long and Short Alert to position for a pullback. I was right. But I never expected such a severe correction.
In a mere five months, the black gold turned into fool’s gold, plummeting over 70%.
In the aftermath of such a historic sell off, it’s only natural that historic opportunities exist. Today we look to capitalize on one…
Business and Industry Overview
This month I’m recommending TEPPCO Partners (NYSE: LP). It’s one of the oldest publicly traded energy master limited partnerships (MLPs), with over 12,500 miles of pipeline.
For those unaware, energy MLPs engage in the transportation, storage, and/or processing of crude oil and natural gas. Much like real estate investment trusts (REITs), the government bestows tax-advantaged status on MLPs. In return, they must pay out the majority of profits. (For a thorough overview of MLPs, I recommend this primer.)
The most important characteristic of MLPs is this – they’re not involved one bit in the exploration and discovery of crude and natural gas. Instead, they just get paid to transport the stuff, based on total volumes, not the price of the underlying commodity.
So while the price of crude might be off some 70%, I guarantee you worldwide demand, and the volumes to be transported, is not. In fact, through November, the American Petroleum Institute estimates demand is only off 6%.
Why then the massive sell off for MLPs? After all, the Alerian MLP Index (Yaho ^AMZ) – a composite of the 50 most prominent energy master limited partnerships – cratered 52% from its high this year.
In a nutshell, retail investors simply panicked and sold en masse without checking the underlying fundamentals. And hedge funds, which invested in MLPs for attractive yields, exacerbated the sell off as they bailed as part of the deleveraging process.
Here’s the thing – MLPs continue to report record earnings, increase distributions and expand operations. Including TEPPCO. But I’m convinced this disconnect between prices and fundamentals won’t last forever.
Nor will the record yields. The average MLP now yields over 12%, the highest in 12 years. What’s more, the last time oil traded around $40 per barrel, MLPs only yielded half as much. So clearly, shares are undervalued.
Once investors regain the smallest appetite for risk, they will flock back into MLPs (for the income and the capital appreciation potential). And there’s plenty of cash to fuel a buying spree, too. According to Federal Reserve data and Bloomberg, investors are sitting on $8.85 trillion in cash, bank deposits and money market funds.
Bottom line – MLPs represent too good an opportunity for income investors to pass up. We’re going to play it with one of the most fundamentally sound choices.
Key Fundamentals
Here are the key fundamentals behind my recommendation of TEPPCO:
- Ample credit to fund capital expenditures. Because MLPs pay out the majority of profits, they rely on secondary offerings and credit to fund growth. But, even in these distressed markets, TEPPCO is in good shape. In the third quarter, it increased its borrowing capacity by $250 million under one credit facility. It also raised $264 million via the capital markets. All told, the company’s sitting on $600 million in liquidity, enough to fund almost all of the proposed capital expenditures in 2009.
- Diversified business mix. Revenues are almost evenly split between upstream, midstream and downstream operations. Plus, the company just added a marine segment (February 2008). Such diversification reduces overall risk, a key criteria for us.
- Conservative growth strategy . Unlike other MLPs, management doesn’t believe in overdosing on debt to fund expansion. In fact, TEPPCO financed 75% of its growth in the last five years through asset sales and equity contributions.
- Minimal exposure to oil prices. TEPPCO does buy and sell some of the oil it transports. But exposure is minimal and hedged (via buy and sell contracts).
- Valuation. TEPPCO currently trades at its cheapest valuation in a decade based on price-to-earnings, price-to-sales and price-to-cash flows ratios.
- Key Assets. TEPPCO owns the only pipeline transporting liquefied petroleum gases form the Texas Gulf Coast to the Northeast. It also is the sixth-largest U.S. inland barge owner. Combined with an easily digestible $1.9 billion market cap, the company’s a prime acquisition candidate.
- Insider buying . Insiders know best and Dan Duncan, the CEO of the general partner that controls TEPPCO plunked down $7 million in September, at roughly double the current prices.
Dividend Yield and Reliability
TEPPCO pays a quarterly dividend of $0.725 ($2.90 annual). At current prices, that’s equivalent to a 16% yield. The next dividend will be paid at the end of January.
I consider the dividend safe and reliable based on the following:
TEPPCO is required by the government to pay out the majority of its profits. Given the underlying fundamentals (noted above), it’s safe to say, there will be plenty to go around.
In terms of reliability, few companies stack up. TEPPCO routinely over delivers on its income promises. In fact, TEPPCO has increased its distribution for 14 years and counting. Less than 200 companies, out of thousands, can boast the same track record.
Important Note About Taxes
Please note that investing in MLPs in an IRA account could result in the cash distributions received being considered unrelated business taxable income (UBTI). This could create a tax liability. Also, please be aware that MLPs report income via a K-1 form, which don’t need to be mailed out until late March. This too could cause potential problems, as the timing might require requesting an extension to file income taxes.
In the end, I’m not a tax advisor and can’t provide individual advice. So I recommend you ask questions first and buy later. Or in other words, consult your tax advisor before investing in any MLPs.
**Action to Take
Buy TEPPCO Partners (NYSE: LP) at $19 or better and set a protective stop at $14.50.
We’ll look to write a covered call against the position at a later date (after receiving our first dividend payment in late January). Right now, the downside risk is so limited, and the upside so significant that it doesn’t make sense to give up the potential gains for a little extra income.
Good Investing,
Louis Basenese
If you have any questions, feel free to call our VIP Trading Services representatives at 888.570.9830 (toll-free) or e-mail: viptrader@oxfordclub.com . Or call Pillar One Advisor Aaron Brabham at 800.329.1984.
Current Portfolio:
Medallion Financial Corp. (Nasdaq: TAXI)
Current Yield: 9.9%
Entry Price: $5.83
Current Price: $7.39
Unrealized Gain: 26.8%
Income Received-to-Date (dividends + option premium): $0.45 or 7.7%.
Total Potential Return (unrealized gain + income RTD): 34.5%
Recommendation: HOLD until the February 2009 $7.50 call option (TQX-BU) we wrote against our position expires. If shares aren’t called away, we’ll look to generate additional income by writing another covered call option.
All Income Tripler recommendations are posted on The Oxford Club website – www.OxfordClub.com Just click on ‘The Income Tripler’
Bi Louis Basenese is the Associate Investment Director for The Oxford Club . He began his career structuring asset protection programs for private business owners and later joined one of Wall Street’s leading investment firms as a top analyst and trading expert. Louis specializes in non-traditional investments such as hedge funds, managed futures, takeovers, IPOs and various other alternative investments. He has an MBA from the Crummer School of Business at Rollins College and draws upon both his academic and professional experiences to edit four elite trading services: The Takeover Trader, The Income Tripler and The Long and Short Alert . Louis also is a regular contributor to the Oxford Club Communiqué and the Oxford Insight e-letter and is a top-rated speaker at financial conferences around the country.
Copyright – 2008 The Oxford Club, LLC. The Oxford Club does not act as a personal investment advisor or advocate the purchase or sale of any security or investment for any specific individual. The Oxford Club provides its members with unique opportunities to build and protect wealth, globally, under all market conditions. The executive staff, research department and editors who contribute to The Club’s recommendations are proud of the reputation The Oxford Club has built since its inception in 1984. We believe the advice presented to its members in our published resources and at our meetings and seminars is the best and most useful available to investors today. The recommendations and analysis presented to members is for the exclusive use of members. Members should be aware that investment markets have inherent risks and there can be no guarantee of future profits. Likewise, past performance does not assure future results. Recommendations are subject to change at any time.
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