The Safety Net: An "A" Rated MLP

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By Wealthy Retirement

Chicago, Jun.13, online stock trading .- In the comments section of last week's The Safety Net column, Stuart mentioned that he read my book Get Rich with Dividends twice and now his son is reading it. (Thanks very much, Stuart.)

He added, "I only wish I had this information when I was his age. My son was asking me about the dividend safety of ARLP and I thought I would ask for your input on this one."

By the way, if you want me to review the dividend safety of one of your stocks, please leave the ticker symbol in the comments section below.

I love the fact that Stuart's son is engaging in this investing strategy at a young age. If he does it well and holds the right stocks for years, he should be setting himself up for a very comfortable future.

Alliance Resource Partners (Nasdaq: ARLP) - a coal producer with a hefty 6.3% yield - is a master limited partnership (MLP).

MLPs offer tax advantages to investors in that their dividends (called distributions) are mostly tax deferred. Investors will not pay taxes on the distribution until they sell the investment - and then it will be as a capital gain.

So from a tax perspective, Stuart's son is likely being smart in owning a stock that has certain tax advantages - as long as the stock is held in a taxable account. Generally speaking, you don't want to own MLPs in an individual retirement account (IRA).

[For more on MLPs and how they work, you can read item No. 3 in this article.]

Cash Is King

In the first quarter, Alliance's revenue increased 23% to $548.1 million while net income grew 24% to $102.9 million.

But when it comes to dividends and distributions, I tend not to be too impressed with net income. There are all kinds of ways to doctor net income. There are non-cash expenses that can be added or reduced, management can push forward or pull through sales and earnings into or out of a quarter, etc.

So what I look for is the amount of cash that was generated in the quarter or year.

So while Alliance made $102.9 million in profit in the first quarter, it generated $112.7 million in distributable cash flow (DCF). DCF is the metric we look at for MLPs to determine if they make enough cold hard cash to pay the distribution.

In Alliance Resource Partners' situation the answer is a resounding "yes." In the first quarter it paid out $69.6 million in distributions against $112.7 million in DCF. So the company is paying out only 61% of its cash flow to unit holders in the form of a distribution, leaving plenty of room to raise the distribution.

For all of 2012, the company's DCF was $372.9 million while it paid $257.9 million in distributions. So, again, plenty of room to raise the distribution.

For dividend growth investors, it's important that a company not pay out all of its DCF or cash flow in distributions, because we want to see a higher dividend every year. And if a company is paying out 100% of its cash flow in dividends and has a bad year or two, it will not be able to continue to increase the dividend without dipping into cash on hand.

When a company pays out 75% or less of its cash flow, even if its business hits a rough patch, it should still be able to continue to raise the dividend in the immediate future.

Alliance has a solid history of raising the distribution. It has done so for the past 11 years at an impressive average of over 15% per year. In the first quarter it raised the distribution by more than 10% over last year and that comes on the heels of another raise in the fourth quarter of 2012.

So we have a company with a solid track record of raising the dividend, growing DCF and plenty of cushion in case the business turns south for a few years.

From a dividend safety perspective, Stuart's son is off to a great start.

Dividend Safety Rating: A

Editor's Note: It's a testament to the free market...

In spite of the rampant ineffectiveness in Washington, American industries are quietly starting to boom. And it's all thanks to companies like Tulsa-based Alliance Resource Partners. Not only is ARLP helping rejuvenate America's "Rust Belt" economy, its stock is up over 29% since it was added to one of the most sought-after portfolios of 2013.

So what's behind this surge in American industry? It starts with a bold $1.2 trillion plan between six U.S. companies. And these companies aren't only driving renewed prosperity in "Middle America," they're propelling our most successful portfolio year-to-date. To get the full details, click here ...