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I don’t blame you.The yields on energy master limited partnerships (MLPs) are very tempting.If you’re not sure what these are, energy MLPs are companies that own the pipelines that transport oil and natural gas around the US.And they often pay huge dividend yields. The top five oil MLPs have an average dividend yield of 5.3%. That’s more than twice the S&P 500 dividend yield of 1.9%.I even found one oil MLP that is paying a crazy 18.4% dividend.But in The Weekly Profit , I’m on the lookout for safe income opportunities .And while the MLP yields are generous, many of them are very unsafe.Here’s why.
MLPs Borrow Money to Pay Dividends
Of those top five oil MLPs I mentioned, the average payout ratio is 104%.The payout ratio is the percentage of net income a firm pays to its shareholders as dividends. So, if a company has earnings per share of $4 and pays $2 in dividends, it has a payout ratio of 50%.Bottom line: The lower the payout ratio, the more sustainable the dividend payment.When the payout ratio is over 100%, the company is actually dipping into its cash reserves to fund the dividend.Or worse, they’re using debt to finance the dividend.A company can’t borrow to pay its dividend for very long. That’s even more true when oil prices are tanking.The Days of Easy Yields Are Over
Oil prices have been in a tailspin since October:
There are two reasons for the decline.The first is rising global supply. Saudi Arabia, Russia, and other producers have been wary of production cuts. This has left markets awash in oil.When supply is rising and demand stays constant, prices tend to fall.The second reason is fear of a global economic slowdown. Weak European economic data and a struggling US stock market have roiled the energy markets.Now, MLP revenue is often directly linked to the price of oil. When prices fall, MLPs make less money.That leaves less money for investing in the business and—you guessed it—paying dividends.And when a company cuts its dividend, it’s bad news for the share price.This Is How the MLP Sector Crashed in 2015
In December 2015, Kinder Morgan ( KMI[NYE] - $16.12 ) was the largest oil pipeline operator in North America.The company had raised its hefty dividend for five straight years… by 30% each year!But oil prices were doing the opposite. They fell from $105 per barrel in July 2014 to $43 in December 2015.Then the unthinkable happened: Kinder Morgan slashed its dividend by 75%.The news shocked investors. Many had piled into the nation’s largest pipeline operator because they thought the 8% dividend yield was safe.When you catch the market off guard, you get punished.Here’s a chart of Kinder Morgan’s share price during this period:
Following the announcement, shares got chopped 28.6%. To this day, they have not recovered.But they weren’t the only company to meet this fate.Major pipeline operators such as Plains All American Pipeline LP ( PAA[NYE] - $22.19), NGL Energy Partners ( ( NGL[NYE] - $9.81 Trade )), and Enbridge Energy Partners LP ( EEP[NYE] - $10.49 ) would soon cut their dividendsThis tanked the entire MLP sector. The Alerian MLP ETF( AMLP[ARCA] - $9.35 ) crashed 47% between June 2015 and February 2016.With cheap oil, the writing was on the wall for many of these companies.Low oil prices reduced the value of the commodity they were transporting. This lowered the company’s earnings and made their dividends less safe.Today, I see a similar pattern with three other companies.Related: Don’t Overlook These 5 Small Cap REITs