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By Jeremy Glaser and Paul A. Larson | 11-26-2012 02:00 PM

MLPs: High-Quality Income Generators

Tax advantages and economic moats allow master limited partnerships to offer investors much more than just high yields, says Morningstar's Paul Larson.

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. With lot of investors searching for yields, MLPs, or master limited partnerships, have become increasingly popular. I am here with Paul Larson. He is Morningstar's chief equity strategist. He is also the editor of Morningstar StockInvestor. He is going to look at why MLPs could be attractive, but also some things to keep in mind. Paul, thanks for talking with me today.

Paul Larson: Glad to be here again.

Glaser: Let's talk about MLPs. They're a little bit different than maybe a standard, so-called C corporations that a lot of investors might be familiar with. Can you talk a little bit about the structure and why people should consider them?

Larson: Sure. I have owned a number of MLPs over the years in the Hare portfolio, in StockInvestor and I was also an energy analyst before managing those portfolios, so I have a little bit of experience in these. And a master limited partnership is basically just a different structure, and what it is, is when you buy the units, or the stock, on the exchange, you actually become a limited partner in the partnership.

And the key difference between an MLP and the C corp. is that now the C corp. pays taxes at the corporate level, whereas the MLP does not pay any taxes at the entity level, at the partnership level. And the partnership's income and losses flow through to the individual owners. So, there are still taxes paid, but it's paid by the individual owners of the partnership, whereas at the C corp., the company is paying taxes at the corporate level. And then there is also the so-called double taxation of dividends issue in that when dividends are paid, those are also taxed.

Glaser: It's certainly a bit of an unusual structure. What kind of businesses can organize themselves as MLPs? Is there anything about the structures of those businesses that makes them more or less attractive to investors?

Larson: Well, these are attractive not only because they have a high yield, but because of the types of companies that are allowed to form under the MLP structure, which is basically midstream energy, these tend to be relatively attractive companies. Pipeline companies tend to have wide moats or in worst case narrow moats.

So, we have a relatively high proportion of high-quality companies that are formed under the MLP structures. Again, it's not just the yield that that should attract people. It is again the relatively stable nature and the wide moats that we find here.

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