The master limited partnership (MLP) sector attracts investors because of the high distributions and the special tax treatment of those distributions. Investors think of these distributions as dividends, though they are actually part income and part return of capital. The sector has had an extraordinary run over the past couple of years as the Federal Reserve has kept interest rates at all-time lows.
Unfortunately, there is an important issue that many companies may soon have to face. To retain their MLP status, they have to pay out 90% of their taxable income to shareholders. To maintain those distributions, they have to increase earnings or make acquisitions. A new report from Oppenheimer suggests that some companies may have a difficult time doing that. The good news is that some of the major MLPs appear to be in solid shape to maintain their distributions.
Exploration and production (E&P) MLPs usually cannot keep their distributions maintained by simply increasing earnings. They need to make acquisitions to keep distributions flat over the long term. The companies are forced to have what the industry calls a maintenance capital spending program. While the concept of maintenance capital spending is straightforward, quantifying it is an exercise in uncertainty. The analysts at Oppenheimer have determined that some companies are way too aggressive and may be forced to cut their distributions if suitable acquisitions and capital are not available.
Here are their top stocks to buy, though some investors may want to be careful here. We would cautiously point out that "yield" is often interchanged with distribution rates for simplicity purposes.
BreitBurn Energy Partners L.P. (BBEP) is a top stock to buy at Oppenheimer and is ranked as very solid in the maintenance capital spending area. Since November 7, 2011, the company has increased its quarterly distribution seven times over the past seven payable months (including the company's most recent payout, which took place on August 8). In July, it announced the acquisition of Whiting's enhanced oil recovery projects in Oklahoma. The Oppenheimer price target for the stock is $21. The Thomson/First Call target is posted at $21 as well. Investors are paid a whopping 10.6% distribution. MLP distributions may include return of principal. The stock closed Tuesday at $17.8.
LRR Energy L.P. (LRE) is another name that falls in the safe category at Oppenheimer. The company has seen solid insider buying over the past year. Co-CEO and Chairman Eric Mullins bought 16,750 shares back in August. The Oppenheimer price target for the stock is $18, while the consensus is at $16.75. Investors receive an outstanding 11.975% distribution. The stock closed Tuesday at $16.15.
Mid-Con Energy Partners L.P. (MCEP) is a stock to buy, but its profile is definitely more aggressive. Revenues are tracking for better than a 40% gain in 2013, and analysts project sales will increase some 15% in fiscal year 2014. The company appears very reasonably priced given its yield at just over 11 times this year's expected earnings. Oppenheimer has a $28 price target for the stock. The consensus target is posted at $26.50. Investors are paid an 8.77% distribution. The stock closed Tuesday at $23.
Memorial Production Partners L.P. (MEMP) is considered a very conservative player in the Oppenheimer universe. Memorial has made an interesting set of acquisitions, which has diversified its production from 88% gas to only 63% today. Memorial picked up "drop downs" from its parent company in the Permian Basin, Rockies and a small set of acreage in California, adding some oil to its mix. The acquired fields are all mature and the geology already has been mapped out. Some of them, particularly one piece of the California acreage, came with 100 experienced employees. All Memorial needs to do is continue operating the properties and collect the cash. The Oppenheimer price target for this top stock to buy is $24, and the consensus target is pegged at $22.50. Investors are paid a 10.3% distribution. Memorial closed Tuesday at $19.77.
New Source Energy Partners L.P. (NSLP) also is considered a very conservative operator by Oppenheimer. The company announced Monday that it has acquired working interests in 25 producing wells and related undeveloped leasehold rights from Scintilla. The properties are located in the Southern Dome field in Oklahoma County, Oklahoma. The Oppenheimer target price for the stock is $23, while the consensus target stands higher at $24. The company pays an outstanding 10.52% distribution. New Source closed Tuesday at $21.04.
Oppenheimer pointed out in its research piece that Linn Energy LLC (LINE) should be avoided, and the firm has an Underperform rating on the stock. It was also less constructive on EV Energy Partners L.P. (EVEP) and Vanguard Natural Resources LLC (VNR). Both of the companies were considered too aggressive and they may not have the ability to safely continue their distributions at current levels.
It is important to note that the stress on the high-yielding MLPs is not as prevalent on the leading large cap names. In fact, the average yield (distribution) in the Alerian MLP index is only 5.7%. Companies like Enterprise Products Partners L.P. (EPD), which yields 4.5%; Kinder Morgan Energy Partners L.P. (KMP), yielding 6.6%; Plains All American Pipeline L.P. (PAA), yielding 4.6%; and Energy Transfer Partners L.P. (ETP), yielding 6.9%, all have far less trouble maintaining their payouts to investors. All four have consistently raised their distributions over the years and appear likely to continue to do so.
MLPs should continue to be good investments and income vehicles for investors. Given the tepid recovery of the economy, and the likelihood that the Federal Reserve does not begin raising interest rates until late next year or 2015, signs for the sector are still positive. It is important when reaching for yield to own the names that can safely maintain their high distributions. The market does not look kindly on high-flying names that end up having to cut their payouts.