Investors, These Battered Pipeline MLPs Are Worth a Look

What they are. Master limited partnerships own energy pipelines, processing facilities and storage depots, collecting fees on the volume of oil and gas they handle. As partnerships, they distribute to investors most of the “available cash” they generate each year (cash on hand after setting aside money for reserves and other business expenses). The stocks, called units, yield 7.7%, on average.

How much they’ve fallen. The benchmark Alerian MLP index plunged 30% over the past year. (Prices and returns are as of October 30.)

What caused the downturn. Low energy prices are putting the brakes on oil production, squeezing industry profits and reducing the need for more pipelines in some areas. MLPs tend to carry massive amounts of debt and could face higher borrowing costs if interest rates rise. Ultimately, MLPs may have to trim future payouts, keeping their stocks depressed.

Why the bears may be wrong. Crude oil and natural gas still need to be piped around the country, and MLPs haven’t stopped making money as the middlemen in the industry. Some MLPs are seeing business dry up and are scaling back expansion plans. But well-managed partnerships are earning enough cash to cover their distributions, and demand for pipelines, terminals and processing facilities continues to rise in parts of the industry, particularly involving natural gas.

The stocks look cheap. Whenever MLP yields have been at least five percentage points greater than the yield of 10-year Treasury bonds (now at 2.2%), the stocks have delivered positive returns 100% of the time over the next 12 months, according to Credit Suisse. Note that MLPs have an unusual tax structure that can be a headache come tax time, so consult with a tax planner before you buy.

What to buy. For a good mix of income and potential for share-price gains, consider Enterprise Products Partners (symbol EPD, $28, yield 5.6%). The largest MLP on the market, Enterprise owns a vast network of pipelines and storage and processing facilities—an integrated model that helps insulate it from weakness in one area of business. Although its yield is below average, Enterprise has a robust balance sheet, giving it plenty of financial flexibility to make acquisitions, expand its business and boost cash flows, says Hinds Howard, of CBRE Clarion Securities, in Radnor, Pa., who runs an institutional fund that invests in MLPs.

Rising demand for natural gas should fuel long-term gains for Williams Partners (WPZ, $34, 10.0%). A natural-gas powerhouse, Williams processes the commodity into other energy products and runs one of the longest gas pipelines in the country. Low commodity prices have dampened profit margins, and Williams’s payouts may be flat over the near term. But Williams should be able to cover its payouts, currently running at an annual rate of $3.40 per unit. That makes the stock attractive for income, says Todd Williams, manager of the Westwood MLP and Strategic Energy Fund. Further, Williams Partners is slated to be controlled by a much larger MLP, Energy Transfer Equity (ETE), which should help support it financially.

Two other MLPs to consider are Tesoro Logistics (TLLP, $56, 5.4%) and Sunoco Logistics Partners (SXL, $29, 6.3%). Tesoro owns terminals, trucks and pipelines around refineries that serve its parent company, Tesoro Corp. Sunoco, controlled by Energy Transfer Equity, has a healthy natural-gas liquids business in the Northeast, along with operations in Texas and other areas. Both MLPs are backed by deep-pocketed corporate parents that can help them expand their business, says Howard, and each should be able to hike its payout by at least 10% annually over the next few years. Even if the stocks languish, investors should fare well just by collecting on a rising stream of income.