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By: Ahmed Ishtiaq

Investment in master limited partnerships is a great way to collect dividends. By definition, a master limited partnership should derive almost 90% of its cash flows from commodities, natural resources or real estate. MLPs enjoy certain tax benefits; the partnership does not pay company level taxes. Instead, the taxes are paid at unit holder level. In this article, we have identified three partnerships working in the energy sector.

Energy partnerships are constantly expanding due to the oil and gas boom in North America. In the past three years, MLPs have averaged 27%, compared to 16.4% for the S&P 500. The partnerships have flourished due to low correlation with the global credit, banking and real estate crisis. We decided to choose three best performing partnerships, and analyzed their financial strength and business prospects. Cash distributions, growth in per unit cash distributions and earnings growth were the main determinants of these picks. We picked these three partnerships with a belief that these can be winners in the long term and generate impressive returns.

Kinder Morgan Energy Partners:

Kinder Morgan Energy Partners, L.P. (KMP) is one of the best MLPs operating in the sector. The company distributes diesel fuel, gasoline, jet fuel and natural gas liquids with its 8,400 miles of pipelines. For the natural gas section, KMP has 16,200 miles of distribution pipelines. KMP has shown exceptional growth over the years. In the previous quarter, the company achieved 78% year-over- year growth in its profits. As a result, KMP increased per share cash distributions. At the moment, per unit cash distribution rates stand at $5.04, annually. At the current level of distributions, the partnership offers a yield of 6.40%.

Per unit cash distribution has increased by 8.6% year-over-year for KMP. However, growth in cash distributions for the first nine months is slightly lower at 6.95%. Cash flow available for distributions has shown remarkable growth for the company. Distributable cash flow for the third quarter before certain items was $455 million, showing a 15% year-over-year growth. On a per unit basis, distributable cash flow before certain items was $1.28 compared to $1.19 for the third quarter last year. Moreover, distributable cash flow per unit for the first nine months was $3.72 compared to $3.40 for the same period last year. A strong business model along with healthy cash distributions makes KMP an ideal candidate for an income portfolio.

Energy Transfer Partners:

Energy Transfer Partners LP (ETP) engages in the natural gas midstream, and intrastate transportation and storage businesses in the United States. Over the years, the company has conducted a number of acquisitions, mergers and divestitures. ETP acquired Louis-Dreyfus holdings and Sunoco, in addition to a merger with Southern Union. However, it is now time for the company to try to integrate these mergers and acquisitions and increase value. ETP has not increased its cash distributions in the past. However, I expect this to change soon. I believe the company will be able to achieve synergies and increase distributable cash flows substantially. As a result, distributions to the unit holders will increase.

For the most recent quarter, ETP reported adjusted EBITDA of $481.7 million, showing year-over-year growth of 19.7%. Distributable Cash Flow stood at $339.5 million, showing year-over-year increase of 27.58%. Furthermore, distributable Cash Flow for the nine months of 2012 was $935.2 million, recording an increase of 13.15% from the first nine months of 2011. At the moment, ETP distributes $3.58 per common unit, yielding 8.45%.

Linn Energy LLC:

Linn Energy LLC (LINE) is a master limited partnership that acquires, exploits, and produces from oil and natural gas properties in the United States. Its major properties are in the Mid-Continent, the Appalachian Basin, and in California. It currently produces more than 200 million cubic feet of natural gas equivalent per day. Recently, the company reported third-quarter results, showing a loss of $430 million. However, the losses mainly come from the wild fluctuations in its hedging program. These hedges have to be marked to market, which can cause wild swings in quarterly income. However, taking a deeper look at earnings reveals that the company earned $0.45 a share, beating the expectations of $0.26. Linn Energy distributes $2.90 annually, yielding 7.60%.

As a result of the fully hedged position, future quarters should show stable underlying earnings. The company reported adjusted EBITDA of $402 million, increasing by 65% from the same quarter last year. In addition, the company achieved a distribution coverage ratio of 1.40X. NGL prices, recent drilling results and acquisitions impacted the distribution coverage ratio. The company has a very strong commodities hedge position. As a result, these earnings have a fairly strong protection. Linn energy has its expected natural gas and oil production hedged almost 100% for six years and five years, respectively.

Summary:

MLPs in the energy sector have shown remarkable returns over the past three years. All of the companies mentioned above have strong business models and attractive growth opportunities. The most important metric, distributable cash flows have increased substantially for all three companies. As a result of the recent boom in the U.S. oil and gas sector, these companies will prove to be the real winners. I expect these three companies to carry on with strong growth and outperform the market. Furthermore, the cash distributions will show a healthy increase over the next two years.

Source: 3 Energy Partnerships For Attractive Returns