Dividend Champions: Focus on Master Limited Partnerships (MLPs)

This will be the first of a series of articles focusing on specific industries and isolating the CCC companies within those industries.
Note:The Dividend Champions spreadsheet and PDF have been updated through 2/28/11 and are available here. Note that all references to Champions mean companies that have paid higher dividends for at least 25 straight years; Contenders have streaks of 10-24 years; Challengers have streaks of 5-9 years. Together, all of these companies may be referred to using the abbreviation “CCC.” What are MLPs? Master Limited Partnerships, or MLPs, are specialized companies that are not organized as typical corporations, instead issuing partnership units in place of common shares. Adhering to special provisions of the tax code, these partnerships are “pass-through” entities that are not subject to taxation, instead passing along all of their income and expenses (and responsibility for any taxation) to owners of these partnership units. Here is a brief description. Note that the criteria for maintaining MLP status requires that the company derive at least 90% of its cash flows from real estate, natural resources, or commodities. The vast majority of the MLPs that are publicly traded are engaged in the area of oil and gas transportation, processing, and storage. A good source of industry-wide information can be found here.
Technically, MLPs do not declare dividends, but instead make “distributions,” generally on a quarterly basis. Because partners also receive an appropriate portion of expenses, such as depletion and depreciation, their net income is typically much lower than the gross amount of the distributions. As a result, taxable income is low and the distributions are largely treated as a return of capital, which reduces the investors' cost basis. Over time, this means that, instead of being taxed on current income, MLP investors will enjoy increasing capital appreciation that has the potential of reducing the cost basis to zero, turning the entire initial investment into a capital gain (when sold), which (currently) would be taxed at rates below those of “ordinary” income. If and when the cost basis is reduced to zero, subsequent distributions are considered current income.... Read more