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3 Toll-Taker MLPs to Buy in 2014

Low-risk profits from America’s energy renaissance


According to Bank of America Merrill Lynch, domestic shale-oil production is expected to quadruple by 2014 from its level only four years previously. A recent Wall Street Journal analysis predicted that the United States was overtaking Russia as the world’s largest producer of oil and natural gas.

With the S&P 500 Index up more than 150% since the March 2009 low, however, I’m wary of domestically focused oil companies. Rather than hope for capital gains down the road, I want to collect as much of my return as possible up front — in the form of cold, hard cash.

Master limited partnerships fit the bill perfectly. In particular, I favor MLPs that operate “toll taker” businesses with repetitive, annuity-like income streams. These partnerships not only dish out an ample cash yield but also possess the financial ruggedness to ride through all sorts of economic ups and downs — even crises like that of 2008.

But before we get to the MLPs  you should own, here’s a more in-depth look at why they’re great holdings for your portfolio.

A Nifty Tax Break

Toll-taker MLPs let you shelter much (sometimes all) of your quarterly cash distributions from current income tax. How? By passing you their hefty depreciation write-offs. Uncle Sam “recaptures” this untaxed income when you sell your partnership units, but that event may be many years from now.

The chief drawback to MLPs is that they create extra paperwork at tax time. If you prepare your own taxes, I encourage you to use a software package like TurboTax or Tax Cut to guide you through the thicket, although even these programs occasionally leave details unclear. For additional background on the tax aspects of MLPs, visit the website of the National Association of Publicly Traded Partnerships.

Great Yields

Like the broader stock market, MLPs performed strongly in 2013, with the benchmark Alerian MLP Index rolling up a total return of 20%. Over the past 10 years, the average MLP has produced three times as much wealth as the S&P 500.

Remarkably, though, many MLPs are still throwing off handsome cash yields. Factor in the prospect of distribution increases in the years ahead, and you’ve got a vehicle that will hedge against inflation as well as any likely rise in interest rates.

Here are three of my favorite buys right now:

Buckeye Partners (BPL)

Buckeye Partners NYSE:BPLAfter a disappointing 2012, this old reliable seems to be regaining its stride. On Oct. 9, Buckeye Partners (BPL) announced that it had signed a pact to buy 20 petroleum-storage terminals, mostly on the East Coast, from Hess (HES) for $850 million. I expect this deal to give a noticeable lift to BPL’s cash flow in 2014, enabling the partnership to pick up the pace of its quarterly distributions.

BPL stock current yields 6.4%. Look for the cash payout to grow 4%-5% per year over the long run, slightly below the industry average (because Buckeye’s pipelines mainly transport refined products like gasoline and jet fuel, as opposed to crude oil direct from the fields). Nearly all of BPL’s debt carries a fixed rate — a helpful “insurance policy” if interest rates go up.

Plains All-American Pipeline (PAA)

plainsAt first glance, a 5% yield from Plains All-American Pipeline (PAA) may not seem eye-popping. However, this organization boasts extraordinary growth prospects.

Plains owns pipelines and storage facilities serving just about all the major regions of North America that produce oil and natural-gas liquids. Over and above its 18,000-mile pipeline network, PAA boasts 5,400 railcars for transporting oil and gas, 1,505 trailers, 800 trucks and 100 barges. Quite an inventory!

In early October, PAA jacked up its distribution for the 17th quarter in a row (a fat 10.6% increase from the year-ago period). What’s more, management predicted that the payout will climb another 10% in the next 12 months. Counting reinvested dividends and price gains, I figure you’ll double your money by 2018, if not sooner.

Kinder Morgan Management (KMR)

kinderWorried about the tax issues involved with MLPs? Try Kinder Morgan Management (KMR). As I’ve noted before, this unusual critter pays quarterly distributions in stock, rather than cash. No income tax — absolutely none — is due on your earnings until you sell your units. Furthermore, if you sell units more than a year after you received them, any profit qualifies as a tax-favored long-term gain. There’s no depreciation “recapture” ever.

Apart from the tax freedom, why buy KMR now? The units carry an implied yield of 7.2%, based on the cash value of the quarterly stock distribution. In today’s market, it’s almost impossible to nail down a 7% yield (much less on a tax-favored vehicle) without taking sizable business or financial risk.

Yet KMR is essentially a clone of Kinder Morgan Energy Partners (KMP), one of the largest and most diversified energy-infrastructure enterprises in the United States. KMP has doubled its quarterly cash distributions over the past 10 years, with each increase flowing to KMR holders dollar-for-dollar (in the form of additional units, which you can sell at any time in the open market). For tax-averse investors, KMR at current valuations is a steal.

As of this writing, Richard Band may hold some of the aforementioned securities in his Profitable Investing portfolio.

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