investing

Energy Stocks That Pay 4% and Up

If you crave income, you’ll love master limited partnerships. We tell you how to spot the winners.

Holders of master limited partnerships got an unpleasant wake-up call recently, when once-hot Boardwalk Pipeline Partners (symbol BWP) slashed its payout and saw its share price plunge. The energy market is changing, experts warn, turning some longtime darlings into duds.

But that doesn’t mean the MLP industry—known for high, tax-favored distributions—is a minefield. Investors simply have to tread carefully. “It’s important to know what the partnership’s assets are, the markets it serves and that it is div­ersified,” says analyst Mark Reichman, of Simmons & Co., a firm that specializes in the energy industry.

MLPs are given special tax treatment as a way of fostering the development of energy infrastructure in the U.S. MLP shares (called units) trade like stocks. As long as the firms have at least 90% of their assets engaged in the extraction or transportation of energy, they’re not taxed at the corporate level. Instead, they pass earnings and tax deductions directly to investors. (Each year, investors get a Schedule K-1 form detailing their share of income as well as deductions.)

Because the U.S. energy market is expanding rapidly, thanks in large part to the shale boom, the MLP market offers plenty of choices. Some old-time darlings, such as Boardwalk, are running aground because their pipes are in areas that have been supplanted by new fields far away. We think the four below, however, are appealing (share prices are as of March 7).

Several years ago, Energy Transfer Partners (ETP, $55, 6.6% yield) had the same problem as Boardwalk: It focused on transporting oil and gas in a narrow geographic area—in this case, the state of Texas. But as production increased, demand did not, which sounded a death knell for its business model, says Morningstar analyst Jason Stevens. Forced to remake itself, the MLP bought a utility, a refiner and a business that transported natural gas, as well as a terminal built to import gas through the Gulf of Mexico. The nation’s glut of natural gas obviated the need for imports, but this terminal has become one of a few authorized to export liquefied natural gas overseas. However, Stevens thinks lingering concerns about the firm’s past keep the stock depressed.

Spectra Energy Partners (SEP, $48, 4.3%), spun off from Spectra Energy Corp. last November, is also attractive, Stevens says. With a presence in the Marcellus shale district in Pennsylvania, Spectra has been building new pipes to New England, Canada, the Midwest and the Atlantic seaboard. The firm already has 1,510 miles of pipelines in and around Tennessee and a significant presence on the Gulf Coast. Stevens thinks payouts will grow at a 7% annual pace.

Like Boardwalk, Enterprise Products Partners (EPD, $67, 4.1%) is a well-established player operating both pipelines and storage facilities. But Enterprise is far more diversified geographically and by product line. It stores and transports natural gas, crude oil and refined products in the U.S. and offshore. It’s also developing facilities for exporting propane and butane. Enterprise is among the few MLPs that retain much of their cash to fund future growth. In 2013, it held on to $1.3 billion of the $3.8 billion that was available for distribution, yet it still lifted payouts by 5%.

Also attractive is OneOK Partners (OKS, $53, 5.4%), which specializes in all aspects of the natural gas market. The firm has been able to grow by building new processing plants and new pipelines for liquefied natural gas, and by expanding through the Williston basin in Montana and North Dakota. Reichman sees distributions growing at a rate of 6% to 8% per year for the next several years.

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