5 Energy MLPs Poised to Pop

Updated from 7 a.m. ET to include Permian Basin Trust recommendation
NEW YORK ( TheStreet) -- Investors seeking high income yields and insulation from macroeconomic volatility might want to consider energy master limited partnerships (MLPs).

Simply put, these investment vehicles are publicly-traded partnerships focusing on midstream energy infrastructure. They're structured to provide everything from state tax to financial flexibility, leaving the companies with abundant cash left over to reward its stakeholders with. Unlike many of the standard energy corporations, they don't pay corporate taxes, don't own risky exploration assets, and don't need to deploy capital for drilling operations.

Units of these investment vehicles are quoted daily on the major stock exchanges in stock market quotations.

"The heart of it is great infrastructure," says James Cunnane Jr., chief investment officer at Famco, a multi-product firm overseeing $6.4 billion.

The Interstate Natural Gas Association of America estimates that between 2011 and 2035 in North America, there's a need for about 1,400 miles a year of new, key natural gas transmission infrastructure; 16,500 miles a year of new, natural gas gathering and processing lines; 800 miles a year of new oil transmission pipelines, and much, much more.

Meanwhile, Dan Spears, a partner at Swank Capital, which specializes in MLPs and has $1.58 billion in assets under management, says MLPs have been a magnet for "people looking for income in an income-starved environment."

These entities have largely been insulated from volatile macroeconomic influences because households and businesses need to be able to access energy no matter what. There are still many underserved energy markets in North America, rendering a build out of energy infrastructure inevitable.

This is one factor that allows these energy infrastructure pure plays to generate steady, stable revenue. Furthermore, they're able to generate revenue based on the amount of volume that they transport, like a toll road, says Famco's Cunnane. While energy prices can swing wildly at the whim of macro trends, volumes generally don't vary to this degree.

Another revenue stabilizer is that the prices charged by long-haul pipeline operators are regulated by the Federal Energy Regulatory Commission.

That said, some investors are worried that the realization of President Barack Obama's latest tax proposals -- some of which is seen as unfriendly towards energy companies -- will hurt the MLPs' tax advantage.

"Will there be a fundamental reform in the tax code?" asks Cunnane. "If there were, that's where I think MLPs would be exposed to a change. When does it become more likely? Maybe in a scenario where the house, senate and presidency are all held by same party."

"They wouldn't be singled out in the change," he continued.

"I think the odds of MLPs being impacted by tax change are extremely minimal over the next year. But there are rising odds as you pass that period -- especially if we end up in a scenario where one party controls all. In a fundamental reform, I think there would be some concern."

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In the meantime though, Spears of Swank Capital thinks that Blueknight Energy Partners ( BKEP) and EV Energy Partners ( EVEP) are among the MLPs with big growth prospects.

Check out TheStreet's quote page for Blueknight Energy for year-to-date share performance, analyst ratings, earnings estimates and much more.

Blueknight Energy, which focuses on crude oil transport and storage and has significant assets in Cushing, Okla. and West Texas, just posted a very strong fourth-quarter profit as well as robust earnings in the previous two quarters; has completed a highly complicated restructuring stemming from difficulties at its former parent SemGroup; and is benefiting from robust domestic crude production and an increased need for crude and crude product storage and terminaling.

"I believe it's on a path towards growth," says Spears.

On EV Energy Partners, Spears says that the company has a "very strong management team" that's been able to deliver on expectations. "Its Utica play is a new play and the prospects look very promising."

The MLP, says Spears, is also in a very good hedged position, limiting its exposure to price risks. The company has hedged out its commodity prices far into the future and 74% of its oil and gas cash flow and production are hedged out this year.

Blueknight has a forward annual dividend yield of 6.5%, while EV Energy's is 4.4%.

Wall Street is very bullish on the EV Energy Partners with all eight analysts covering the stock at either strong buy (6) or buy (2), and the 12-month median price target sitting at $93.50, implying potential upside of more than 30% from current levels.

But Wall Street is more cautious on Blueknight Energy Partners, with one analyst covering Blueknight having a hold recommendation and the other having an underperform view. The 12-month median price target sits at $7 vs. Wednesday's close at $6.41.

Check out TheStreet's quote page for EV Energy for year-to-date share performance, analyst ratings, earnings estimates and much more.

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Cunnane, meanwhile, says that Plains All American ( PAA), Enterprise Products ( EPD) and DCP Midstream ( DPM) combine reasonable yield with very good positioning in the expanding U.S. infrastructure landscape. The three are engaged in slightly different parts of the midstream energy space.

Wall Street is bullish about Plains All American, with 13 of the 16 analysts covering the stock at either a strong buy (6) or buy (7), and the 12-month median price target sitting at $85 vs. Wednesday's close at $78.37.

The sell side also likes Enterprise Products with 19 of the 22 analysts covering the shares at either a strong buy (10) or buy (9), and the 12-month median price target at $55 vs. Wednesday's close at $50.67.

The view of DCP Midstream is split with six of the 12 analysts covering the stock at either a strong buy (3) or buy (3), and the 12-month median price target sitting at $52 vs. Wednesday's close at $45.45.

Spears thinks that MLPs as a sector should provide a mid-teen return over the course of 2012. For diversified exposure to the sector, he recommends Swank's Cushing MLP Premier Fund.

Famco's Cunnane sees low double-digit returns from his MLP recommendations. Generally, he thinks the MLP universe as a whole should grow at a slightly over 5% a year rate over the next five years and offer yields above 5%. The corresponding growth metrics for Plains, Enterprise and DCP should be several percentage points higher than that of the average MLP. The three now have respective forward annual dividend yields of 5.2%, 4.9% and 5.5%.

Despite their many benefits, the MLPs issue a K-1 tax form that complicates the already complicated tax filing process, over the years discouraging investors from pursuing the opportunities they present. But it's now possible to get around this problem by investing in these cash machines through exchange-traded funds, exchange-traded notes and mutual funds. With these, investors would get a standard 1099 form instead.

Cunnane says that investors should make sure to check whether they're giving up anything for these diversified investment vehicles, as some of them are levered and riskier and have to pay taxes at the fund level.

Also, MLPs, being far less liquid than energy giants such as Exxon ( XOM), can exhibit volatility levels between that of equities and fixed-income products, as they have characteristics of both.

Advisors say as long as the fundamentals remain solid and the company is still delivering cash, investors shouldn't worry too much about the volatility.

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Investors wishing for even steeper investment vehicle returns, but with the MLP-like tax advantaged yields may want to look at energy royalty trusts such as Permian Basin Trust ( PBT). They also don't face corporate income taxes.

Permian, a relatively small entity, has been "running under the radar," says Bill Gunderson, president of Gunderson Capital Management, who tracks about 2,800 different stocks and exchange-traded funds. Permian has a forward annual dividend yield of 7.3% and comes in at a stellar 95 out of 2,815 stocks in Gunderson's stock ranking system, which is based on value, performance and safety. Over the last ten, five and three years, Permian has generated total returns of 25.7%, 18.8% and 40.3% respectively.

A cautionary note is that royalty trusts, unlike MLPs, are based not on the more steady pipeline business, but rather on energy production, which means investors would have to stomach the wild swings of energy prices and swings in production levels; cash flows and returns can be inconsistent. Trusts don't have any of their own physical operations, management or employees as they're financing vehicles operated by banks. Still, they trade like stocks.

"Trusts are required to pay out essentially all of their cash flow as distributions," says Morningstar. "Due to depreciation and depletion, distributions from most trusts are not considered income in the eyes of the Internal Revenue Service."

Check out TheStreet's quote page for Permian Basin Royalty Trust for year-to-date share performance, analyst ratings, earnings estimates and much more.

-- Written by Andrea Tse in New York.

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