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Get A 9.6% Yield With The Best MLP You've Never Heard Of

Daniel Cross

Bond investors have a good thing going for them. They finance part of a company's operations in exchange for a return of capital at a later date and pocket steady interest payments along the way. 

True, they miss out on any growth the company might have, but for the most part they're exposed to minimal risk.

But what if you could have both an equity position and receive a high yield as well?

Enter the master limited partnership (MLP). This asset class behaves much like common stocks do; they're highly liquid, and as a shareholder, you benefit from the growth of the company. The secret to the appeal of MLPs lies in the tax treatment. Unlike a standard corporation, MLPs aren't required to pay any taxes; instead they pass it on to unit holders. 

The net effective tax rate for corporations in the U.S. is 40%. Dividends are issued only after all taxes have been taken out. Because MLPs bypass taxation, they pay out 90% or more of profits to the shareholder resulting in higher than average dividend yields. 

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MLPs are primarily tied to energy commodities, a sector that's been red-hot for the past couple of years. Thanks to a harsh winter season, natural gas inventories have been depleted to 11-year lows. U.S. consumption of natural gas averaged 91.2 billion cubic feet a day between November and March -- a relatively large increase of 10% over the same period the previous winter and 13% over the average during the past five winters. 

The Energy Information Administration expects a vigorous injection season in order to replenish depleted gas storage levels that should last until October. This catalyst could be the springboard for one Texas-based MLP, Niska Gas Storage Partners (NYSE: NKA)

Niska's primary business is the storage of natural gas. NKA was downgraded by an analyst at Barclays earlier this year, but it has been on an upward streak with revised guidance after a brief initial dive on the news. Growth estimates for earnings per share (EPS) next year are high for the gas utility sector -- over 27%. NKA trades at 21 times future earnings but under its book value of $15.86, making it an attractive play for income and growth. 

The MLP stands out among its peers with a price-to-free cash flow ratio of less than 14 -- the industry average is actually negative. This gives Niska the ability to make acquisitions and capital expenditures to grow at a much faster pace than other utility companies. 

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Competitors like Buckeye Partners (NYSE: BPL) and TransCanada Corp. (NYSE: TRP) should also benefit from the rising tide in natural gas. Both companies trade at roughly the same P/E, but neither offers the double digit growth prospects Niska does. Additionally, while Buckeye and TransCanada offer high dividend yields (5.7% and 3.7%, respectively), Niska has the highest yield in the sector at 9.6%.

Risks to Consider: Niska is exposed to price fluctuations in natural gas and the storage of natural gas that could affect future earnings. As an MLP, it pays out a large portion of earnings in the form of dividends, which could be impacted by actual cash flows after paying expenses and debt obligations.

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Action to Take --> NKA trades at an 8% discount to its book value and expects positive earnings next year of $0.66 a share. Combined with the dividend yield, this stock should conservatively gain 17.5% over the next 12 months.

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