Cedar Fair: The Thrill Is Gone

You'll never catch me on Cedar Point's Top Thrill Dragster. One look at a photo of the world's tallest, fastest roller coaster throws me into acrophobic panic. Just the same, I've been keeping an eye on the Ohio amusement park's parent, Cedar Fair. Its 5.6% dividend yield inspires in me a positively cozy feeling.

That's before the nagging doubts. Can Cedar Fair, which runs seven large amusement parks, plus five water parks, really offer such a rich yield? Or is it like some midway illusion? The answers are important to anyone seeking income from their portfolio, in part since they don't apply just to Cedar Fair. Like 47 other active issues, most of them trading on the New York Stock Exchange, Cedar Fair is not a corporation but a master limited partnership. Because of that, its $1.84 annual payout is considered a return of capital and so is not directly taxable, not even at today's low rates (15% or 5%) on most corporate dividends.

A 5.5% YIELD THAT'S TAX-FREE? You're right, that is way too good to be true. As a partnership, Cedar Fair each March sends its investors (or, in partnership lingo, "unit holders") a Schedule K-1. This Internal Revenue Service form details each unit holder's share of Cedar Fair's income, depreciation, and other expenses. Income allocated to each unit holder is taxable at ordinary income-tax rates. For a high-income investor, that could easily be 35% or more, after state levies. So a decision to invest in Cedar Fair or the other publicly traded partnerships is considerably more complicated.

The first question, though, is not taxes but the health of the enterprise. Attendance was up a bit, thanks to a park it bought last year. Without that acquisition, though, attendance would have declined 2.5%. When the company reports 2004 results in mid-March, Wall Street expects 6% growth in revenue, to $540 million, but a 10% or so decline in earnings, to perhaps $1.50 a share, as the acquisition drove depreciation and other noncash charges higher. You can see this modest slump reflected in the price of Cedar Fair units. In any case, Cedar Fair's cash flows remain healthy. In the 12 months ended September, cash flow from operations neared $158 million, which proved more than enough to fund a 46% rise in capital spending plus 3.8% more in distributions, now running 46 cents a share each quarter.

So, how much of Cedar Fair's distributions do investors get to keep after taxes? The answer depends not just on your tax bracket but also on how long you hold the investment. Because of the way tax rules call for depreciation expenses to be allocated to partners, after the first year of owning Cedar Fair you would have to pay income tax on only a small slice of your distributions, perhaps 18%. But from there, it gets worse. After eight or nine years, when unit holders' share of partnership income is little sheltered by depreciation expenses, 90% or more of the distribution amount would be taxable. Averaged over the years, an amount equivalent to 50% to 60% of a long-term holder's distributions winds up being liable for current taxation, Cedar Fair Treasurer Brian Witherow told me. Uncle Sam recovers the rest once the shares are sold. This makes Cedar Fair and the other partnerships especially suitable for investors who expect one day to be in lower income-tax brackets or those who want to pass the investment on to heirs, for whom the tax liability gets erased.

Because Cedar Fair's revenues, cash flows, and distributions have grown nicely since 1987, when it adopted the partnership structure, investors in that time saw average annual pretax returns of more than 14%. Much of that came as Cedar Fair bought parks, such as California's Knott's Berry Farm, from other operators. In the future, if fewer acquisition targets present themselves, Cedar Fair may have a harder time generating such returns. Like most every shiny carnival prize, Cedar Fair's yield turns out on close inspection to be duller than first glimpsed.

By Robert Barker

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