Bill Gross made a lot of money for his investors (and himself) at PIMCO, the asset management company he co-founded. Forbes estimates his net worth at $1.7 billion. He made most of his money investing in bonds (he is known as the ‘Bond King’).
Today, Gross favors a different kind of income-generating investments: master limited partnerships (MLPs). Here it is a look at why he chooses them over others pipeline supplies for those looking for a tax-efficient income.
Bill Gross recently wrote about the benefits of investing in MLPs, such as Partners for business products (NYSE:EPD) And Energy transfer (NYSE:ET), about pipeline companies, such as Kinder Morgan (NYSE: KMI) And Williams (NYSE:WMB). For starters, MLPs currently have much higher returns compared to their peers:
All four midstream energy companies generate stable revenues, supported by long-term contracts and government-regulated rate structures. Furthermore, they all pay out about 50% of their predictable cash flow to investors in the form of dividends (or distributions for the MLPs). The main difference between the two groups is their rating.
Shares of Kinder Morgan and Williams are up about 40% and 50% respectively this year, while units of the MLPs are up about 20%. That’s why the pipeline companies are acting now bee about 20 times their revenues, while the MLPs sell for about 12 times their revenues.
In addition to earning a higher income stream, MLPs offer a unique tax benefit. MLPs benefit from a tax-deferral feature on their distributions, which allows investors to defer taxes on a meaningful percentage of their distributions until they sell their units.
Gross did the math and wrote, “The deferral of compound interest could add as much as about 1% over an average period of five to 10 years, turning the 8% average into a 9 to 10% dividend yield on your wallet.” That extra percentage point can add up in the long run.
Gross dove into the two main factors driving the gap between MLPs and pipeline stocks. He noted that many investors don’t like receiving the Schedule K-1 federal tax forms MLPs drive their investors every year (pipeline companies send a 1099-DIV form). These K-1s can complicate individual tax preparation and increase costs, so many investors avoid these entities.
Meanwhile, some pipeline companies have a competitive advantage which they mainly transport natural gas (Kinder Morgan and Williams are leaders in gas infrastructure). That potential positions them for more growth in the coming years as gas demand rises, fueled in part by the need to power data centers for artificial intelligence. That optimism about gas demand has boosted Williams and Kinder Morgan’s valuations this year.
However, there is still a lot of growth in the MLP pipeline. Enterprise Products Partners has a A backlog of billions of dollars of commercially insured capital projects, revealing growth through 2026. Meanwhile, Energy Transfer has consolidated the midstream sector and expanded its business organically.
The MLPs are expanding their gas infrastructure and midstream footprint to support oil and refined products. Moreover, they are expanding their export capacity. That growth should allow these MLPs to continue increasing their distributions. (Enterprise has increased its payout for 26 years in a row, while Energy Transfer plans to grow its payout 3% to 5% annually going forward.)
Add it all up and MLPs trade at lower valuations and higher yields, offer better tax benefits, and are still growing at a brisk pace. That’s why Gross believes MLPs are a better long-term investment.
In addition to Energy Transfer and Enterprise Products Partners, he likes fellow MLPs Western Midstream, Plains All-American Pipeline, MPLXAnd Hesse Middle Streamwhich currently offer returns of 7% to 9%. While all are focusing more on oil-related infrastructure, they expect to further expand their footprint and distribution payments in the coming years.
Bill Gross knows a thing or two about generating high returns from income-generating investments. While he became a billionaire by investing in bonds, currently sees the best return potential from MLPs, thanks in part to their tax benefits. While MLPs have drawbacks, they offer attractive return potential given their high-yield distributions, which should grow in the coming years.
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Matt DiLallo has positions in Energy Transfer, Enterprise Products Partners and Kinder Morgan. The Motley Fool holds and recommends positions in Kinder Morgan. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
This Billionaire Income Investor Now Favors These Ultra-High-Yield Dividend Stocks was originally published by The Motley Fool
