Master Limited Partnerships for Income (Barrons)

Master Limited Partnerships



: A Good Place to Get 6% Payouts
By DIMITRA DEFOTIS
Five energy plays that could stoke your portfolio.
Every day, a veritable ocean of oil cascades through thousands of miles of pipelines crisscrossing America, making its way from shipping ports and exploration fields to refineries and end users. A similarly vast tangle of pipes does the same kind of job for natural gas. And then there's the pipeline for investors.

Master limited partnerships, which typically process oil and gas, store it and move it through pipelines, are producing some of the best yields anywhere -- typically 6% and sometimes more. And the outlook for these ventures is excellent.

MLPs pay out most of their cash flow as dividends, or "distributions." MLPs are exempt from corporate taxes. But investors are taxed on some of their distributions annually. Taxes on the rest are deferred until units are sold. In the meantime, the structure can provide hefty payouts year after year, and the deferred tax burden disappears at the unit holder's death -- making the MLP an attractive wealth-transfer tool.

The industry, which has assets of about $250 billion, should have plenty of growth ahead. Traditional energy companies are likely to sell more assets to MLPs for the tax savings and yield. In addition, partnerships have ample borrowing capacity to fund expansions. The profits from all that will flow to investors through payouts.

Yes, there are risks. MLP unit prices are on the high side right now, and payouts could suffer as interest rates and borrowing costs rise. Still, some of the sharpest investors in the field are expecting double-digit total returns for some time to come.

"If you look at where MLPs are trading relative to similarly risked assets, we think the yield is attractive," says Terry Matlack, co-founder of Tortoise Capital Advisors, which manages MLP closed-end funds. "The sector continued to grow distributions through the teeth of the economic downturn."

ANY FURTHER IMPROVEMENT in the economy would help MLPs by lifting demand for energy. Plus, a recent federal tariff increase has brought about clarity on pipelines' pricing in the coming years, says Kyri Loupis, who directs MLP strategy within Goldman Sachs' investment-management division. He holds several pipeline players, including Plains All American Pipeline (ticker: PAA), Magellan Midstream Partners (MMP) and El Paso Pipeline Partners (EPB).

Houston-based Plains transports, stores and markets crude oil, liquefied petroleum gas and related products. The current rise in oil prices could give the stock a nice nudge. Because futures prices of oil right now are higher than the current price, companies like Plains that can store crude and sell it later have greater power in negotiating storage fees.

Plains is the largest operator of storage in the energy hub of Cushing, Okla., and also has storage in Illinois that can hold Canadian crude. Plains pays a 5.9% yield, and brokerage house Stifel Nicolaus thinks distributions per unit could increase 4% in 2011, boding well for the yield.

Magellan, based in Tulsa, Okla., stores and transports refined petroleum products. It expects 7% growth in its annual distribution in each of the next two years, a growth rate that should exceed the sector average, Loupis says.

Magellan is attractively priced: Its enterprise value (market value plus net debt) is 13.3 times its adjusted Ebitda (estimated earnings before interest, taxes, depreciation and amortization, all adjusted for earnings paid to a general partnership), below the industry average of 14.3. Its yield is 5.1%, according to Wells Fargo. Plains is trading at an adjusted Ebitda multiple of 20.5, but pays a higher yield.

The largest energy partnership around, with a market capitalization of $36.5 billion, is Houston-based Enterprise Products Partners (EPD). It operates thousands of miles of pipelines, and processes and stores natural gas, oil and related products. Enterprise has been making some promising moves and, in the process, streamlining a convoluted operating structure, says portfolio manager Tom Cameron, who allocates about 20% of the Rising Dividend Growth Fund (ICRDX), to MLPs.

Enterprise has absorbed its general partner; merged with Teppco Partners, a pipeline company spinout; and recently announced its intention to merge with Duncan Energy Partners, a pipeline MLP. Enterprise Products isn't particularly expensive, with an enterprise value to Ebitda multiple of 13.8. Its yield is 5.4%.

The beauty of pipelines is that they collect steady fees based on volume, rather than volatile commodity prices. Natural-gas pipelines are all the more attractive as the country increasingly turns to this clean-burning form of energy. Natural-gas pipeline operators like El Paso Pipeline stand to benefit handsomely. This MLP was carved out of the exploration and production company El Paso in 2007. The parent still has pipeline assets that it's likely to "drop" into the tax-efficient MLP structure, a practice that has increased distributions 50% since 2007. El Paso's yield is 4.7%, and it looks reasonably priced with an enterprise value to Ebitda of 13.4.

Beyond pipelines, there's a coal play worth a look: Natural Resource Partners (NRP), a Houston-based MLP. Formed in 2002 with properties sold by U.S. railroads and coal companies, NRP leases land to America's biggest coal companies. Its land produces 5% of all U.S. coal and its contracts wisely hedge against drops in coal prices.

NRP is now acquiring 200 million tons of coal reserves in the Illinois basin, with production beginning in 2012. That should contribute to 5% to 6% annual distribution growth starting in 2012, according to Dallas-based Swank Capital. NRP trades with a multiple of enterprise value to Ebitda of 16.2, and its yield is 6.1%.

Investments like these could be just the thing to fire up your income.

.E-mail: editors@barrons.com

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