March 2010 Master Limited Partnerships An Outstanding Track Record And A Promising Future Malcom Day, CFA Partner, Eagle Global Advisors An Outstanding Track Record: A Quarter Century of History Master Limited Partnerships (MLPs) have been around for more than 25 years: The limited partnership units of Dorchester Minerals and its predecessor partnership have been publicly traded and paying distributions since 1982 while the first pipeline MLP, Buckeye Partners, has been publicly traded and paying distributions since 1987. By the early 1990 s the partnerships that would come to be named Kinder Morgan (Enron Liquids), ONEOK (Northern Border), Enbridge (Lakehead), NuStar (Kaneb), and Enterprise (TEPPCO) were all publicly trading and paying distributions. With the track record of the past 20 years of experience, we believe that MLPs have demonstrated substantial benefits to investors and add value to a well diversified portfolio. We believe that current economic and financial market conditions point to a promising future for MLP investments. As shown in the table to the right, the total return from investing in MLPs over the past 20 years has materially exceeded the return of other publicly traded asset classes, outperforming REITs (the next best asset class) on average by more than 5.5 percentage points per year, U.S. equities by over 7 percentage points, and Treasury Bills by more than 11.5 percentage points. Asset Class Total Return 1990-2010 (annualized) MLP 15.5% REIT 9.9% High Yield Bonds 8.7% U.S. Small Cap Equities 8.3% U.S. Large Cap Equities 8.2% Investment Grade Bonds 7.4% Emerging Market Equities 7.0% Municipal Bonds 6.5% International Equities 4.5% Treasury Bills 3.9% See page 6 for sources and disclosures. Mr. Day is Chairman of the Master Limited Partnership Investment Committee at Eagle Global Advisors. Prior to joining Eagle, he founded Partners Investment Management & Research, LLC, an advisory firm specializing in publicly traded partnerships. Mr. Day was also employed previously by Criterion Investment Management Company and Payden & Rygel Investment Counsel where he managed portfolios in excess of $5 Billion. He earned an MBA from the Anderson School at UCLA and a Bachelor of Engineering from Northwestern University. A Chartered Financial Analyst, Mr. Day is also a member of the CFA Institute and the CFA Society of Houston. Eagle Global Advisors, LLC 5847 San Felipe, Suite 930, Houston, Texas 77057 713.952.3550
$8 $7 Growth of $1 Invested 1996-2009 Alerian MLP Index $7.55 $6 $5 $4 $3 $2 $1 S&P 500 $2.32 Barclays Govt/Credit $2.24 Alerian MLP Index S&P 500 Barclays Govt/Credit Source: Eagle Global Advisors Actual investing costs not reflected in index returns; The chart is not intended to reflect the results of any investor or group Outlook Is For Further Favorable Returns MLPs have been able to produce attractive returns through a combination of high current yield and strong cash distribution growth. The basic total return proposition for an investment in MLPs, is the MLP s starting yield plus distribution growth. If there is no change in MLP yield, this sum should approximate the MLP s total return. At the end of 2009, the yield for the Alerian MLP index was approximately 7.4%. We project that cash distributions will rise by approximately 4% during 2010, so total returns for the MLP index are projected to be roughly 11% if MLP yields remain unchanged. In most years the yield on MLPs does not remain unchanged, so returns for 2010 could be higher or lower, but over the last 5 years MLP yields have averaged 7.3%, so current yields are a reasonable basis for longer term valuation. 2
Attractive Yields, Particularly After Tax MLP s current absolute yield of 7.4% is slightly higher than its average for the past five years, and compares well to other investments. The partnership structure provides for a more favorable tax treatment relative to other investments, with typically over 75% of distributions tax-deferred. The after tax attractiveness of MLPs relative to dividend paying stocks will likely increase when the marginal income tax rates and tax rates on qualifying dividends rise, currently scheduled to occur in 2011. As of 12/31/2009: Current Gross Yield Current Yield After Tax MLP Index 7.4% 6.8% Utility Index 4.2% 3.6% 10 Yr AAA Muni Bond 3.3% 3.3% 10 Yr Corporate Bond 5.0% 3.3% REIT Index 3.7% 3.1% Assumptions: 35% marginal income tax bracket, reported income is 25% of MLP distribution (i.e. 75% deferred). Dividends taxed at 15%. REITs income is 50% ordinary income and 50% return of capital (deferred). High Relative Yields 12% 10% 8% 6% Yield Advantage MLP vs. Treasury and Corporate Bonds 4% 2% 0% 3.54% 0.95% -2% -4% -6% 1/31/1996 11/30/1996 9/30/1997 7/31/1998 5/31/1999 3/31/2000 1/31/2001 11/30/2001 9/30/2002 7/31/2003 5/31/2004 3/31/2005 1/31/2006 11/30/2006 9/30/2007 7/31/2008 5/31/2009 MLP over Treasury MLP over Corporate Sources: Eagle Global Advisors, Barclay s - Treasury Bond is 10 Year Treasury Note, Corporate Bond is Barclay s Long Baa Index MLP Yields are significantly above their long term median levels relative to 10 year Treasury bonds and investment grade corporate bonds. 3
High Real Yields MLPs have a track record of increasing cash distributions over time. Thus, unlike a bond, an MLP can generate higher yields based on the original investment than contemplated at the time of purchase. Similar to bonds, MLPs may produce lower yields when the issuer becomes distressed. The ability of MLPs to increase their distribution is a function of many factors, including successful investments and acquisitions, but historically MLPs on average have grown their distributions at a significantly higher rate than inflation. Not all MLPs have succeeded in growing their distributions, and some MLPs have reduced or eliminated their distributions over the last 20 years. Since MLPs own and operate real assets, we anticipate that they will be able to grow their distributions at rates at least equal to inflation in the future. Since MLP distributions can rise by the rate of inflation or better, a comparison of MLP yields with other real yield securities, like Treasury Inflation Protected Securities (TIPS) makes sense. REITs also own real assets that should be able to increase their cash payments by the rate of inflation or better, so we also compare MLP yields to REITs in the graph below. MLP Yields remain well above the median as compared to both TIPS and REITs. 10% Yield Advantage MLP vs. REIT, TIPS 8% 6% 5.20% 4% 2% 2.07% 0% -2% -4% 4/30/1998 3/2/1999 1/2/2000 11/2/2000 9/2/2001 7/2/2002 5/2/2003 3/2/2004 1/2/2005 11/2/2005 9/2/2006 7/2/2007 5/2/2008 3/2/2009 1/2/2010 MLP over REIT MLP over TIPS Source: Eagle Global Advisors MLP Unit Prices Remain Low Compared to Cash Distribution Payments From day to day MLP yields and prices fluctuate, but over time (in a stable inflation environment) yields tend to revert to the median level, while unit prices rise in conjunction with cash distributions (thus keeping yields roughly unchanged). Since the unit price relationship to distributions should remain fairly constant over the long term, we can compare the current weighted average MLP price to the current weighted average distribution and obtain a sense of valuation relative to history. 4
MLP Unit Prices Remain Low Compared to Cash Distribution Payments 3000 MLP Distribution Growth vs. Price 1993-2009 with 2010 Distribution Projection 2500 2000 1500 1000 500 0 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Distributions Prices Indexed 1993 = 1000 Indexed 1993 = 1000 Source: Eagle Global Advisors The chart above shows that weighted average distributions for MLPs have been quite stable with a gradual increase over time, punctuated by occasional plateaus. The market price of MLPs, however, has been much more volatile as it is subject to a host of emotional factors. In 2008, a series of technical factors combined to push MLP prices to extreme low levels relative to distributions. The gap narrowed in 2009, but MLPs remain undervalued relative to the growth in distributions that have taken place over time. A Promising Future In light of MLPs outstanding track record and attractive current valuations, we believe that MLPs have a promising future for investors. We believe that the ongoing need to expand the nation s energy infrastructure will provide additional opportunities for MLPs to invest and generate distribution growth. Further, many large integrated energy firms, such as ConocoPhillips, BP, and Chevron have indicated interest to sell existing infrastructure assets that would be well suited for MLPs. The cost of debt and equity capital for MLPs has also declined substantially over the past year, allowing MLPs to build and buy assets at significantly accretive rates, thereby promoting further increases in distributions to investors. We think that the combination of attractive valuation and improving growth prospects make for a promising future for the MLP asset class. Opinions and recommendations are as of 3/15/2010. 5
Master Limited Partnerships: An Outstanding Track Record and a Promising Future April 2010 Disclosures Asset Class Returns, Page 1 Sources: MLP - Alerian 1996-2010, Eagle MLP 1990-95; REIT - NAREIT; High Yield Bonds, Investment Grade Bonds, Municipal Bonds - Barclay s; U.S. Small Cap, U.S. Large Cap - S&P; International Equities - MSCI, Treasury Bills - Bloomberg. Performance presentation is not intended to represent the performance of any client of Eagle Global Advisors. Eagle MLP Index The Eagle Master Limited Partnership (MLP) Index, is a total return index which describes the returns from investing in Master Limited Partnership units (MLPs). The Eagle MLP Index reflects the returns for MLPs across all industries including energy, real estate, finance, and other industries. Energy partnerships account for approximately 92% of the index, while real estate, and other currently represent approximately 5%, and 3%, respectively. The construction of the Eagle MLP Index enhances its usefulness as a measure of the Master Limited Partnership asset class. The Eagle MLP Index is rules based, so the inclusion or exclusion of individual MLP companies is independent of any subjective decisions. Additionally, the Eagle MLP Index is float weighted, which results in a superior representation of the return of all money invested in Master Limited Partnership units, as compared to an equal weighted index. Also, the Eagle MLP Index is free of survivorship bias, since all MLP companies that meet the criteria for any given time period are included, including MLP companies that are no longer in existence. 6