6 Energy MLPs to Buy for Income and Turnaround Potential

 | Jul 15, 2018 | 1:00 PM EDT
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Tim Plaehn, an income specialist and editor of The Dividend Hunter, believes midstream energy master limited partnerships are near the start of a multi-year recovery. George Putnam, editor of The Turnaround Letter, also sees a brighter long-term future for select MLPs. The two investment experts and MoneyShow.com contributors offer their top picks for MLP investors.

George Putnam, The Turnaround Letter

Like many stocks in the energy sector, master limited partnerships, or MLPs, remain out of favor. These companies generally focus on transporting, processing and storing oil and natural gas, with revenues based primarily on commodity volumes rather than on commodity.

They differ from most stocks because they are structured as publicly traded partnerships, and therefore are not subject to federal income taxes at the company level.

With their focus on stable, cash-producing operations and free from the burden of federal income taxes at the partnership level, MLPs often pay generous distributions to unit holders, resulting in attractive yields that have averaged 7% or more in recent years.

Of course, as with any investment, there are downsides to be considered. With high payouts to unit holders, MLPs often must rely on borrowing and additional equity offerings to fund their growth.

Unit holders receive K-1 tax statements instead of 1099s, and tax-deferred accounts may be subject to UBTI (unrelated business taxable income), among other tax complexities. Also, as interest rates increase, the relative attractiveness of MLP yields may diminish, adding a source of pressure to the traded unit prices.

When energy prices began their steep decline in mid-2014, many MLPs suffered from the symptoms of over-zealous growth in response to the earlier energy boom: too little retained cash, too much leverage and too much investor exuberance. More recently, a pending rule change by the Federal Energy Regulatory Commission (FERC) could force multi-state pipelines to reduce prices.

Now many MLPs are returning to more conservative policies. Some have eliminated their incentive distribution rights (IDRs) and simplified their complex structures. Distributions are now more in line with cash generation, meaning future cuts are less likely. Critically, investor expectations are much lower today.

Fundamentally, strong energy demand along with healthy production growth means increasing volumes of crude oil and natural gas flowing through pipelines and a brighter future for many MLPs. Listed below are four MLPs that look particularly interesting to us right now.

Energy Transfer Partners LP (ETP) carries considerably more risk than many other MLPs, reflected in its high 11.8% yield and beaten-down share price. A major issue is its governance. Billionaire Kelcy Warren is chairman of both the MLP and its general partner.

Other problems include the company's $34 billion debt, thin distribution coverage and the risk of another dilutive equity offering. However, pressure may be mounting on chairman Warren to restructure the two companies' relationship, which could lead to a share price boost. The company has an impressively large and valuable asset base and trades at a discounted valuation.

Formed by Marathon Petroleum Corp.  (MPC) in 2012, MPLX LP (MPLX) operates over 10,000 miles of oil and natural gas pipelines, along with storage, processing and other facilities primarily in the eastern United States.

MPLX LP has steadily increased its cash distribution and has guided to a 10% increase this year. It continues to have ample growth opportunities, particularly in the prolific Marcellus/Utica basins.

With Marathon's acquisition of refiner Andeavor  (ANDV) , the Andeavor-related MLP will likely be combined with MPLX LP, providing access to western U.S. opportunities. Governance appears healthy: Marathon Petroleum owns 64% of the units, helping to align interests, and MPLX LP eliminated the IDR conflict earlier this year.

Shell Midstream Partners LP  (SHLX) holds a diversified portfolio of onshore and Gulf of Mexico pipeline assets, product terminals, storage facilities and natural gas gathering lines in the Permian Basin.

Distributions have nearly doubled in the past three years. Its parent, Royal Dutch Shell (RDS.A) , offers a steady stream of additional properties that Midstream Partners anticipates purchasing, providing future growth.

A much-needed equity raise was completed in February, which will help improve the balance sheet and finance acquisitions. Another positive is that much of its pipeline system won't be subject to upcoming federal regulatory changes.

The company may undertake an expensive transaction to eliminate its IDRs, but this should enhance its otherwise high quality. With its recent share price weakness, largely related to its dilutive equity offering, this MLP appears likely to provide a rewarding return.

Western Gas Partners LP (WES) owns natural gas gathering and processing facilities, as well as a promising water gathering network and other assets, in the Rocky Mountains, Pennsylvania and Texas. Distribution growth is likely to remain healthy, at about 6%-7% over the next few years.

With its heavy capital spending likely to taper next year, the company is evaluating whether to distribute much of the increased cash flows or reinvest in new projects. Last year, Western Gas converted preferred units to common stock, removing a cash drain.

Anadarko Petroleum  (APC) , the MLP's high-quality sponsor, holds a relatively high 34% of the Western Gas units, which reduces the likelihood of conflicts of interest. The company also appears to have only limited exposure to the pending change in FERC regulations.

Tim Plaehn, The Dividend Hunter

The signs suggest that the energy infrastructure/midstream sector has set up for a multi-year bull market recovery from the declines of the previous two years. A handful of energy midstream companies have gotten a jump on their peers and have already put up nice gains to date in 2018. These energy sector leaders still have plenty of upside runway and it is not to late to join the ride with these stocks.

The steady growth in North American production of crude oil and natural gas is increasing the need for midstream services. The energy infrastructure companies are filling their pipelines, processing plants and storage terminals.

They are launching new projects to handle the forecast growth. Revenues, free cash flow and dividends paid to investors are on the upswing. You can expect these companies to lead the pack for the rest of the year.

CNX Midstream Partners LP (CNXM) is an MLP that owns, operates, develops and acquires gathering and other midstream energy assets to service natural gas production in the Appalachian Basin in Pennsylvania and West Virginia. The company operates in the Marcellus and Utica shales, the most prolific natural gas play in the U.S., if not the world.

This MLP primarily provides services to CNX Resources Corporation (CNX) , which has a significant portfolio of midstream assets to be transferred to the MLP. CNXM has provided distribution growth guidance of 15% per year through at least 2022. The CNX Resources units currently yield 6.4%.

Plains All American Pipeline LP (PAA) owns and operates the largest independent network of crude oil gather systems, crude oil long distance pipelines and crude oil storage facilities. The company has the largest gathering presence in the rich Permian energy play.

It has one of the best pipeline takeaway capacities and is leading the charge to build new pipelines out of the Permian. This region is the growth engine of U.S. oil production and Plains All American Pipelines is best positioned to benefit from the production growth. Plains should resume distribution growth in 2019. The shares currently yield 5.1%.

The company offers alternative shares in Plains GP Holdings LP (PAGP) . Both securities pay the same distribution rates. Each Plains GP Holdings share is backed by a Plains All American unit. The difference is that Plains GP is a 1099 reporting company for tax purposes.

-- This article was originally published July 12 on Real Money

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