It’s a good strategy to invest in income growth companies, sit back, and reap the rewards. But to beat inflation, investing in high yielding, yet stable companies is important. And this is exactly where companies with an MLP (Master Liability Partnerships) status roll in.
MLPs are generally oil and gas companies that generate consistent cash flows. They distribute the bulk of their cash generated and don’t have to pay corporate taxes. In turn, unit holders are liable to pay taxes on their distributed earnings. However, even after deducting taxes, certain companies yield greater returns than many of the highest yielding dividend income stocks.
Enbridge Energy Partners, L.P. (NYSE:EEP) sports a hefty yield of 7.31% with a payout ratio of 293.22%. The company has just $241.5 million in cash and cash equivalents, which is certainly not enough to cover its annual cash distribution of $682 million. However, Enbridge Energy Partners, L.P. (NYSE:EEP) generated $799.4 million in operating cash flows (TTM), which can comfortably sustain its distribution payout (distribution coverage ratio of 1.17x).
The problem with having a low distribution coverage ratio is that companies aren’t left with enough cash for expansive activities. But Enbridge Energy Partners, L.P. (NYSE:EEP) is a mature operator with over 6,500 miles of oil pipelines, and over 11,500 miles of natural gas pipelines. With such an extensive reach, its financial performance is largely dependent on organic growth.
However, Enbridge Energy Partners, L.P. (NYSE:EEP) has planned a 600 mile-long pipeline project that would connect North Dakota Bakken oil fields to its Superior facility. The overall project cost is estimated to be around $2.5 billion, which would most likely be financed by debt. But Enbridge Energy Partners, L.P. (NYSE:EEP) is already highly leveraged, with a debt/equity ratio of 137%.
However, due to FERC’s rejection, the project timeline has been delayed by 2-3 years. Income investors can find solace in the news, as Enbridge Energy Partners, L.P. (NYSE:EEP) can now continue with its hefty distribution without straining its balance sheet (at least for the next couple of years).
A Growth Play
Amongst these companies, Enterprise Products Partners L.P. (NYSE:EPD) is the largest oil company with a huge market capitalization of around $56 billion. Contrary to the general belief that MLP’s deliver steady returns over time, its shares have risen by 31% over the last year. And to top it all off, its shares yield 4.5% with a relatively low payout ratio of 93.18%.
For the recent quarter, the company posted a 32% increase in its distributable cash flows along with a record quarterly net income of $754 million. Its spectacular financial performance can be attributed to its Eagle Ford NGL pipeline (constructed last year), which led to a 532% surge in its quarterly NGL production from Southern Texas.
During the earnings call, its management also stated,
“We have another $2.2 billion of growth projects that we expect to complete during the remainder of this year and an additional $5.3 billion of projects under construction that are scheduled to begin service in 2014 and ‘15.”
With such an aggressive growth trajectory, Enterprise Products Partners L.P. (NYSE:EPD) seems to have all the ingredients for a perfect value play. And with a distribution coverage ratio of 1.33x along with liquid positions worth $1.28 billion, the sustainability of its $2.453 billion worth of annual cash distributions is hardly a cause for concern.
A Value Play
According to several research reports, Enbridge and Enterprise Products Partners L.P. (NYSE:EPD) have a price target 10%-15% higher than their current prices. However, analysts at Deutsche Bank are particularly bullish on Kinder Morgan Energy Partners LP (NYSE:KMP), with a price target of $102 per share (around a 25% premium).
The company acquired Copano Energy for $5 billion last month, with an aim to bolster its midstream business in Texas and Oklahoma. Copano currently operates with 6,900 miles of natural gas pipelines, and owns 9 processing plants with a total processing capacity of over 1 billion cubic ft/day. On the other hand, Kinder Morgan Energy Partners LP (NYSE:KMP) operates with around 46,000 miles of pipelines and 180 storage terminals.
Its management stated, “The acquisition will add at least 10 cents per unit to Kinder Morgan Energy Partners LP (NYSE:KMP)’s earnings for at least the next five years beginning 2014.”
With that, its not hard to justify why the street is bullish on Kinder Morgan Energy Partners LP (NYSE:KMP). At the current price, shares of Kinder Morgan Energy Partners LP (NYSE:KMP) yield 6.2% and analysts estimate its annual EPS to grow by 11.8% for the next 5 years.
Final words
As clear as it gets, all the mentioned companies carry high yields with ample share appreciation to offer. In my opinion, portfolio diversification is of vital importance and creating a portfolio of all three companies (instead of picking one) would be a great way to spread the risks and rewards.
The growing production of natural gas from hydraulic fracturing and horizontal drilling is flooding the North American market and resulting in record-low prices for natural gas. Enterprise Products Partners L.P. (NYSE:EPD) Partners, with its superior integrated asset base, can profit from the massive bottlenecks in takeaway capacity by taking on large-scale projects.
The article 3 High Yielding MLPs That Offer Significant Upside originally appeared on Fool.com.
Piyush Arora has no position in any stocks mentioned. The Motley Fool recommends Enterprise Products Partners L.P.. Piyush is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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