An “A” Rated MLP

Marc Lichtenfeld

In the comments section of last week’s The Safety Net column, Stuart mentioned that he read my book Get Rich with Dividends twice and now his son is reading it. (Thanks very much, Stuart.)

He added, “I only wish I had this information when I was his age. My son was asking me about the dividend safety of ARLP and I thought I would ask for your input on this one.”

By the way, if you want me to review the dividend safety of one of your stocks, please leave the ticker symbol in the comments section below.

I love the fact that Stuart’s son is engaging in this investing strategy at a young age. If he does it well and holds the right stocks for years, he should be setting himself up for a very comfortable future.

Alliance Resource Partners (Nasdaq: ARLP) – a coal producer with a hefty 6.3% yield – is a master limited partnership (MLP).

MLPs offers tax advantages to investors in that their dividends (called distributions) are mostly tax deferred. Investors will not pay taxes on the distribution until they sell the investment – and then it will be as a capital gain.

So from a tax perspective, Stuart’s son is likely being smart in owning a stock that has certain tax advantages – as long as the stock is held in a taxable account. Generally speaking, you don’t want to own MLPs in an individual retirement account (IRA).

[For more on MLPs and how they work, you can read item No. 3 in this article.]

Cash Is King

In the first quarter, Alliance’s revenue increased 23% to $548.1 million while net income grew 24% to $102.9 million.

But when it comes to dividends and distributions, I tend not to be too impressed with net income. There are all kinds of ways to doctor net income. There are non-cash expenses that can be added or reduced, management can push forward or pull through sales and earnings into or out of a quarter, etc.

So what I look for is the amount of cash that was generated in the quarter or year.

So while Alliance made $102.9 million in profit in the first quarter, it generated $112.7 million in distributable cash flow (DCF). DCF is the metric we look at for MLPs to determine if they make enough cold hard cash to pay the distribution.

In Alliance Resource Partners’ situation the answer is a resounding “yes.” In the first quarter it paid out $69.6 million in distributions against $112.7 million in DCF. So the company is paying out only 61% of its cash flow to unit holders in the form of a distribution, leaving plenty of room to raise the distribution.

For all of 2012, the company’s DCF was $372.9 million while it paid $257.9 million in distributions. So, again, plenty of room to raise the distribution.

For dividend growth investors, it’s important that a company not pay out all of its DCF or cash flow in distributions, because we want to see a higher dividend every year. And if a company is paying out 100% of its cash flow in dividends and has a bad year or two, it will not be able to continue to increase the dividend without dipping into cash on hand.

When a company pays out 75% or less of its cash flow, even if its business hits a rough patch, it should still be able to continue to raise the dividend in the immediate future.

Alliance has a solid history of raising the distribution. It has done so for the past 11 years at an impressive average of over 15% per year. In the first quarter it raised the distribution by more than 10% over last year and that comes on the heels of another raise in the fourth quarter of 2012.

So we have a company with a solid track record of raising the dividend, growing DCF and plenty of cushion in case the business turns south for a few years.

From a dividend safety perspective, Stuart’s son is off to a great start.

Editor’s Note: It’s a testament to the free market…

In spite of the rampant ineffectiveness in Washington, American industries are quietly starting to boom. And it’s all thanks to companies like Tulsa-based Alliance Resource Partners. Not only is ARLP helping rejuvenate America’s “Rust Belt” economy, its stock is up over 29% since it was added to one of the most sought-after portfolios of 2013.

So what’s behind this surge in American industry? It starts with a bold $1.2 trillion plan between six U.S. companies. And these companies aren’t only driving renewed prosperity in “Middle America,” they’re propelling our most successful portfolio year-to-date. To get the full details, click here.

Dividend Safety Rating: A

29 Responses to “An “A” Rated MLP”

  1. Ken Morris says:

    How safe is the HPF dividend?

  2. arthur geller says:

    Coal is NOT the fuel of the future. So many serious pollutants include mercury, lead, carbon in spades. Gas is cheaper to obtain, easily shipped via pipeline, immeasurably cleaner to burn and plentiful. Coal will linger as a boiler fuel for awhile, not wishing to upset West Virginia and Kentucky voters but it’s inevitable that production and use will fall. Probably the biggest markets will be exports

  3. Vijay says:

    Hi Marc

    I do follow your Safety Net emails. I have one basic question with dividend investing. I am 50 year old and have around 30K in savings and around 30K in my IRA. I am wondering how much could I earn by investing this amount in dividend reinvestment stocks. Would it provide me with some decent funds to take care of my retirement. Please let me know how this strategy would help me.

    thanks

    Vijay

    • Vijay,

      In order to come up with a figure, we’ll have to make some assumptions.

      Let’s assume your portfolio averages a 4% starting yield, 10% average annual dividend growth and the stock rises by the 7.48% historical average of the S&P 500.

      After 15 years (at age 65), your $60K would be worth $353,960. If at that point you decided to keep the shares and take the income, you would be paid $17,774 in annual dividends or a 29% yield on your original cost. Of course, the dividends should keep growing after that as well.

      If you decided not to touch the funds until age 70, it would be worth $678,118 and would kick out over $38K in income. You can see how powerful compounding gets particularly the longer you go.

      I have a dividend calculator at http://www.getrichwithdividends.com where you can plug in your own variables and see what kind of numbers you come up with.

  4. ED DANIELS says:

    PLEASE COMMENT ON CLMT—-HAVE SEVERAL OF YOUR RECOMMENDATIONS AND VERY PLEASED

  5. Troy Mohon says:

    How do you feel about SMLP?

  6. ARP, Atlas Resource Partners LP $22.50, 9.07% dividend yield.

  7. David Holleb says:

    What is your rating on A T & T compared to verizon?

  8. MaryEllen H Rhoney says:

    TANN…..safety of dividend?? Thanks

    I enjoy your work.
    MER

  9. Mary Jane Aubuchon says:

    P&G

  10. Gabby says:

    Perfect asnewr! That really gets to the heart of it!

  11. Bruce says:

    GAUCX GABELLI UTILITY FUND. MANDATED .07 per month div. not sure how they can continue to do that. I hope you can shed some light on this.

    Thanks

  12. Franklin D. Lomax, Sr. says:

    WastingtonDC: I have correctly renamed our national capital, for the elected criminals who are daily helping their friends, and their own parties, to destroy the American Republic, starting with US Taxpayer’s US dollar. It is my copyrighted Byline, in articles and commentary, and obviously, the perfect name for the DC Metro area.

    You said: Leave the symbol for stocks on which you’d like us to review the dividend potential. I’d like your ideas, on GGN, one of the Gabelli family of funds, the whole family totals some $30 billion. The GGN fund is said to use some $1.3 Billion, of gold and energy producer stocks, and does the Buffett, selling covered calls, to pay its 12.5 dividend, with monthly payments. They have done perfectly the past years since I bought them, at $19/share, and lower, as GGN’s price dawdles down, and hopefully back up, along with the paper price of gold. In the April Fool’s crime, as the paper gold manipulators drove the price of their non-existent promises down to a price low enough to cause the next upward blast for gold in the ground, or real energy producers, I doubled our stake in GGN, at the $12.12/share, price I had never seen before, hoping to drive my monthly dividends as high as a hundred shares per month, now, and god knows how high, over the decades, if they keep paying the monthly levels I have enjoyed, since my first purchases of GGN. The Gabelli family appears to have existed and done business fairly well, every day of our lives, so can they continue those 12.5% GGN dividends, and remind us of the rule of 72/12.5, which says the total position will double in less than six years.

    My decision was driven by the Cyprus jokes, along with our decade long experience with CVX, Chevron shares inherited in 2003, at the IRA fixed basis of $37/share. Due to that rule of 72, the original shares, purchased, I’d estimate, in my Beautiful Bride’s tweens, or my teens, at some $7/share, to $12/Share, are now paying us annual dividends of nearly 20%, making us most attentive to any stock that may actually comply with the 72/dividend rate compounding period.

    My estimate of the potential GGN dividend increase was careful, but clearly not high enough. On April 24th, after my doubling buys, GGN paid me $1502, or $139+ shares, perhaps due to a DRIP’ing Dividend reinvestment price of an amazing $10.74. As I marveled, stunned, for 32 days, by that lucky break, the second post doubling dividend arrived, on May 24th, at $1523, with a few tenths of a share closer to 140 GGN Shares.

    Since both those dividends equaled more than an ounce of gold’s daily price equivalent, with the first dividend possibly compounding enough to cause a $20+ rise in the second one, it appears that my Fabulous Four Grandkids will enjoy a dozen or more yearly ounces of gold equivalent dividends, just as they will enjoy the results of their Great Grandmother’s Chevron’s now 20%, and by then, an inestimable percentage, each year of the half century or so before their Mother, who’ll act as our trustee, hands those GGN shares over to them, along with all the other shares we have no intention of ever drawing upon, unless Bernake’s ongoing Real Great Depression, forces us to eat them.

    Do you think the Gabelli Funds Family can continue this excellent performance, and do you think the paper price of gold will rise over the next half century?

    Thanks!

  13. EdInvests says:

    I own arlp, but I don’t think any coal business has a safe dividend for much longer.

  14. ghaber says:

    dividend is great but the coal industry appears to have a finite life . coal stocks are down . the price is at more risk than the 6% per year

  15. jim kiehl says:

    KTF A closed end bond fund. Your thoughts please.

  16. John H from LB says:

    I went to Yahoo.com and looked up the financials for ARLP. When I looked at the Cashflow sheet for the period ending December 31, 2012 I see a different story. After subtracting Capital Expenditures of $424,631,000 from Cash Flow from Operating Activities of $555,856,000, this leaves only $131,225,000. The Dividends paid were $257,923,000 for the year. How can you say the dividends are safe? Where does the money come from to pay for the dividends? Borrowed money? Please advise asap.

  17. John Kooistra says:

    Marc, what do you think of ETP and what was your response to Frank Lomax’s question about GGN shares and their sustainability?

  18. Minh says:

    Is “ABB” dividend safe?
    Should I hold tis stock or sell it?

    Thank you,
    Minh

  19. Mark Reents says:

    Marc..

    Thanks for the article on ARLP. I am curious though on the route to determining or defining DCF, especially with an MLP. I assume you back out Capex but do you include debt (borrowings)? Using Yahoo’s numbers in the annual Cash flow I could not come up with the same numbers you used in your article. Perhaps a little discussion about DCF (definition, formula?? etc.) in one of your articles might give us all clarity and we would all be smarter investors!

  20. freeman suttles says:

    Would you please look at and comment on genesis energy (GEL)

  21. Phil Visser says:

    Hi Marc,

    What do you think about MO (Altria Group)?

    Will you rate them as a dividend safe company.

    Thanks for your answer.

    Phil.

  22. Richard Ligarski says:

    I hold some AGNC It pays a good dividend but the price keeps falling. I don’t know if I should it or bail out.
    Thanks

  23. Douglas Peacock says:

    What do you think of Northern tier energy (NTI) as an investment. Same question as to CRR Refining (CVRR). Thank you.

  24. Rob says:

    I’m also interested in your thoughts on the safety of CVRR.

    Also on ALDW, both MLP’s, with dividends in the 20% range.

  25. Creig says:

    Dear Mark,
    Could you talk about (LLL) please? It looks sound and is in a good sector for growth. Thank you.

  26. Tom Gully says:

    Mark

    What do you think about investing in TNH Terra Nitrogen for growth and income over the long haul? Reinvesting dividends.
    Thanks
    Tom

  27. lloyd says:

    what do you think about ARR?

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