Expect Good Luck With These 13 Best Buys

It seems more than a little counter-intuitive, to say the least, to call any master limited partnership a Best Buy while the market exits are still jammed by thoroughly dissatisfied unitholders.

Their panicky selling has certainly set up some long-term opportunities, but there are no guarantees that the bottom has been reached, and no shame in waiting for a clear shift in sentiment before commencing bargain hunting.

But we are committed to maintaining a list of Best Buys culled from our many current recommendations, and offer this updated version not just for the next few weeks but for the balance of the year and beyond.

As such, it contains partnerships barely exposed to low oil prices as well as those that should actually benefit from them, alongside others that should roar back once current prices prove insufficient to meet longer-term global oil demand.

One new wrinkle to this list is that it groups our top picks thematically. Notably, the first three are all large MLPs with significant growth opportunities and ample financial flexibility. They deserve to be core holdings in every midstream investment basket.

Picks 4-6 are primarily oil refining plays, including two corporate refiners reaping the rewards of operating affiliated MLPs and one particularly promising refinery logistics provider. As hard as low energy prices have been on the drillers, they’ve proven a godsend to the downstream refining sector, boosting fuel demand and inflating profit margins.

Pick 7 is a similarly blessed distributor of discounted fuel, but also the first of three Best Buys tied into the continuing development of the Marcellus shale, one of the world’s lowest-cost energy basins. The Marcellus offers attractive returns even in this depressed environment and should do a lot better over the next year or two as new outlets for its natural gas come on line.

The final four picks are all tanker operators, split evenly between those focused on crude and the traffickers of refined products. The powerful rally in crude tanker charter rates has stalled of late, one reason these stocks are still on sale at attractive profit multiples. But these remain markets with strong and improving fundamentals, which is why we’re fine with the heavy 31% allocation to tankers in this paper portfolio.

1. Magellan Midstream Partners (NYSE: MMP)

The leading shipper of refined fuels got 68% of its cash flow last year from this steady, long-term business with built-in fee increases tied to inflation. Crude pipelines linking major Texas producers with demand centers delivered another 23% of the cash, much of it also tied to multi-year contracts with fixed commitments. In all, Magellan says only some 15% of its business has direct commodity exposure, and the partnership actually increased annual profit guidance when it reported quarterly results earlier this month. The annualized yield is 4.4% based on a distribution recently increased 16% year-over-year, with a 30% cushion of surplus coverage. Magellan is committed to increasing its payout 15% this year and at least 10% in 2016. As the owner of its general partner, Magellan doesn’t have to pay out GP incentives like MLPs run by corporate sponsors. Buy Conservative recommendation MMP below $90.

2. Energy Transfer Equity (NYSE: ETE)

The fast-growing general partner overseeing what is now a huge and very successful midstream family has benefited from adept acquisitions. It’s also secured much of the long-term upside from growth at affiliated partnerships. Rival Williams (WMB) has so far resisted ETE’s merger offer, but with midstream assets in a deep slump founder Kelcy Warren won’t suffer from a shortage of alternative targets. ETE has just increased its distribution 39% year-over-year and now yields 3.8%, while its main affiliate, Energy Transfer Partners (NYSE: ETP), is offering an 8.7% yield and 8% annualized distribution growth despite the drain of ETE’s incentives.  Though ETE’s unit price is down 20% from the June 15 record high, it’s still at levels first reached in June 2014 in an impressive show of resilience and outperformance. Buy Growth recommendation ETE below $75.

3. Enterprise Products Partners (NYSE: EPD)

The largest and most conservatively managed MLP, Enterprise has been badly hurt of late by its very size amid widespread midstream selling, as well as by its limited exposure to the slumping price of natural gas liquids. But its NGL pipelines, fractionators and port terminals along the Gulf Coast would be impossible to replicate, and it’s the essential midstream processor many drillers simply couldn’t do without. The yield is now up to 5.5%, and though the distribution is growing more slowly than those of the most comparable rivals, it’s protected by a superior cushion of surplus cash flow, so that the yield and the growth can be maintained even if the slump lasts years.  Buy Conservative recommendation EPD below $42.50.

4. Marathon Petroleum (NYSE: MPC)

The Midwestern and Gulf Coast crude refiner is already benefiting from some of the strongest refining margins in years, as the persistent glut of cheap domestic crude further stimulates resurgent demand for gasoline. Now it’s using the expensive equity of its refinery logistics MLP to buy out MarkWest Energy Partners (NYSE: MWE), a leading Marcellus midstream processor, on the cheap. That deal not only delivers significant business diversification but will also dramatically increase the cash flow to MPC as the MLP’s general partner in the coming years. Neither benefit appears to have been priced in; in fact MPC may not even be getting full credit for its current refining bonanza. Buy Aggressive recommendation MPC below $70.

5. 
Western Refining (NYSE: WNR)

Western profits from its sector’s strong fundamentals and the cheap equity capital provided by its own pair of MLP affiliates. Shareholder friendly management returned more than 10% of the market cap to investors last year, primarily via a special dividend. Buy Aggressive recommendation WNR below $57.

6. Delek Logistics Partners (NYSE: DKL)

The logistics affiliate of a small but fast-growing southern refiner, DKL is benefiting from the broad  refining upturn while developing several new pipeline projects on its increasingly popular turf. The sponsor’s recent acquisition of a majority stake in another small refiner with logistics assets of its own could boost growth further. In the meantime, the yield secured by long-term contracts with the sponsor is up to 5.4%, and DKL plans annual increases of 15% or more for the foreseeable future. Buy Growth recommendation DKL below $52.

7. UGI (NYSE: UGI)

Once primarily an eastern Pennsylvania gas distribution utility with an unbroken string of dividend payments stretching back to 1885, the company has lately diversified into midstream merchant services to take advantage of the overlap between its turf and the Marcellus shale. As such, it has tackled the development of new gas pipelines for producers and the construction of small-scale liquefied natural gas plants designed to expensively satisfy the peak demand from nearby power plants. The third major prong in UGI’s business strategy is propane distribution via its many recently purchased subsidiaries across Europe, and in the U.S. under the brand of its affiliated AmeriGas Partners (NYSE: APU) MLP. With propane recently at longtime lows, distributors should find plenty of room to ratchet up their margins, something AmeriGas has done in a variety of commodity environments. Buy Growth recommendation UGI below $45.

8. EQT (NYSE: EQT)

A leading Marcellus driller with extensive holdings in the basin’s liquids-rich sweet spot, EQT has seen its realized price premium shrink alongside the price of natural gas liquids. Yet it continues to rapidly ramp up production, making up some of the price pain on volume. Like most of the recommendations above, EQT is also an enthusiastic developer of affiliated income vehicles, spinning out first its midstream operations and then its general partner interests in those as separate securities. With domestic natural gas prices poised to increase over the medium term, perhaps sharply, EQT will be a major beneficiary, not least because its midstream MLP is getting an increasing share of its pipeline traffic from other nearby producers. Buy Aggressive recommendation EQT below $100.

9. EQT Midstream Partners (NYSE: EQM)

EQT’s affiliated midstream MLP derived 61% of last year’s revenue from transmission contracts with an average remaining term of 17 years, and another 21% from firm 10-year gathering contracts. Given the competitive cost advantages of gas drilling in the Marcellus sweet spots served by its pipes, that makes the business all but bulletproof, supporting plans for annual distribution growth of 20% through 2017. And though a growing proportion of the total cash flow will be paid out to EQT as the general partner, owning both securities limits that drag. Both EQT and EQM would be worth much more if natural gas rallies significantly from current levels over the next 18 months, as it well might. At current equity and energy prices, the downside seems much more limited. Buy Growth recommendation EQM below $100.

10. DHT Holdings (NYSE: DHT)

Our favorite oil tanker play is, like the rest of the energy shipping sector, benefiting from revitalized demand after years of overcapacity and heavy ship owner losses. Tankers are saving a bundle on the cheaper bunker fuel, while profiting from the fact that a lot of the Atlantic basin’s surplus crude now is making lengthy journeys to Asia, displaced from U.S. shores by shale production. They’re also increasingly in demand for offshore storage. DHT is benefiting from a well-timed acquisition of tankers shortly before charter rates shot up, and has increased its dividend to a projected annual yield above 7%, with cash flow sufficient for a double-digit payout. Tanker stocks have lagged well behind increases in charter rates so far this year, but that could change if the current dip in those rates proves short-lived. Buy Aggressive recommendation DHT below $10.

11. Scorpio Tankers (NYSE: STNG)

Scorpio ships refined fuels rather than crude, but this market too has seen impressive gains in rates since the big drop in the oil prices cranked up refinery output around the globe. The trade in fuel products is benefiting from the long-haul exports by new refineries in the Mideast, as well as the continued strength in US product exports to Latin America.

The average daily charter rate of Scorpio’s fleet was up 84% year-over-year in the second quarter amid continuing strong demand for fuel tankers.

But what’s really driving Scorpio’s earnings power is its rapidly growing fleet, ordered almost in its entirety at the low prices prevailing before the upturn began. By now the fleet numbers 76 mostly brand-new Scorpio-owned tankers, along with an additional 17 vessels chartered from other owners.

With the hectic pace of deliveries set to slow, there will be more scope to increase a dividend currently yielding 4.8%. Buy Aggressive recommendation STNG below the increased limit of $12.

12. EuroNav (NYSE: EURN)

One of the largest oil tanker fleet operators in the world, EuroNav is riding the same bullish charter market fundamentals as DHT, with the added draw of promising to pay out 80% of net annual after-tax income as dividends. Based on the first quarter’s distribution and the current share price that policy could deliver a double-digit yield this year. Buy Aggressive recommendation EURN below $18.

13. Capital Products Partners (NASDAQ: CPLP)

The MLP operates fuel and oil tankers under multi-year charters, and its unit price has been remarkably volatile, providing another good entry point amid current malaise. The current yield of nearly 13% is fully covered by cash flow, and after holding the distribution steady throughout the shipping slump management looks conservative in forecasting annual growth of 2 to 3%. Buy Aggressive recommendation CPLP below $10.

 

 

 

 

 

 

Stock Talk

Donald Christensen

Donald Christensen

Your ETE recommendation of buy below $75.00 appears a little unrealistic since the stock is only at about $28.69 since the stock split about a week or so ago. Is this supposed to be abvout $40.00?
Please clarify.

Igor Greenwald

Igor Greenwald

Sorry, yes, that price target preceded the split and will be updated to $37.50 momentarily.

TedQ

TedQ

Some midstream MLPs are regarded as conservative investments if they lack significant commodity price exposure. However, if prices remain low for an extended period, the financial stability of parties contracting for guaranteed throughput could become an issue. Is this a realistic risk, and is it measurable?

Igor Greenwald

Igor Greenwald

That’s absolutely a concern, though it would be hard to quantify given the limited public disclosures about identity of customers and the constantly shifting perception of their crediworthiness. The good news is the biggest flows tend to come from the larger and typically more creditworthy producers. The better news is that for wells already drilled someone will need to move and sell that output regardless of ownership. For commitments based on wells not yet drilled or completed the risk is higher, obviously, which is why we’ve tried to focus as much as possible on natural gas and refined fuel shippers, along with refiners, tanker operators, etc.

Mr. Ed, The Talking Horse

Mr. Ed, The Talking Horse

Igor, any insight as to why the shipping companies have sold off quite a lot lately….CPLP, DHT, etc? Thanks.

Igor Greenwald

Igor Greenwald

There’s turmoil in the equity and credit markets obviously, plus this is the traditional seasonal lull for crude shipping rates, which have come off some from the summer peaks. But it’s the overall sentiment more so than anything industry or stock-specific, I think. And the tanker market fundamentals remain robust, as I tried to show in the last issue.

Mr. Ed, The Talking Horse

Mr. Ed, The Talking Horse

Igor, thank you for your views on shipping. I’ve since done some additional due diligence and agree.

Regarding MPC, they’ve sold off close to 10% in last five days…more than other MLPs, etc. Any particular reason for this that you know of? Thanks.

Igor Greenwald

Igor Greenwald

Yes, I think the immediate prompt is that the big BP Whiting refinery, mostly idled for last two weeks, may come back up to full speed as soon as this weekend, taming the Midwest gasoline spike that took place while it was down. Now, I don’t think that merits the 7% haircut, but you can see what sort of market sentiment we’re dealing with right now. Best cure for it, as always, will be time.

Mr. Ed, The Talking Horse

Mr. Ed, The Talking Horse

Yes very ugly out there.

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