2 energy favorites: Kinder Morgan and El Paso Pipeline

The master limited partnerships provide high income as well as growth leveraged to the energy sector.

By TheStockAdvisors Dec 1, 2011 10:18AM
Image: Oil Well Pumpjack © Roger Milley/Vetta/Getty ImagesBy Stephen Leeb, The Complete Investor

The case for commodities is clear, but so is the case for income. What better way to kill two birds with one stone than to invest in income plays leveraged to commodities.

Here are two of our favorites -- master limited partnerships in the energy area poised to capitalize on high oil prices.

Master limited partnerships (MLPs) are required to distribute the bulk of their cash flow to stockholders. This assures high income. In many cases, as commodity prices rise, it also assures growing income, as well.

The first of our recommendations is what has to be acknowledged as the king of the energy-related MLPs: Kinder Morgan Energy Partners (KMP).

It owns 37,000 miles of pipelines, nearly 200 terminals, and moves massive amounts of virtually all energy products, from carbon dioxide (which is used to revitalize old oil wells) to oil and natural gas.

The company has a remarkable record of raising distributions for at least the past 15 years.

By investing, you are pocketing a 6% yield and very likely can look forward to distributions that increase 5% to 10% a year. At the low end, this means total returns of 11%, whereas the upside could deliver total returns of 16%.

El Paso Pipeline Partners (EPB) is a company that began trading at the end of 2007. Its first distribution in 2008 was $1.01 a unit; expected distribution in 2011 is $1.87 per unit, and projected for 2012 is $2.10 per unit.

The current yield of 6% is not only attractive in itself, but becomes extraordinarily attractive when one considers that distributions should easily grow at a 9% or greater clip over the next five years.

One thing to note here is that Kinder Morgan's parent company Kinder Morgan (KMI) recently took over EPB's parent company El Paso Corp. (EP).

EPB dropped on the news. The reason is that EPB had largely grown in recent years by purchasing assets from EP.

Therefore, the transaction means that KMI may decide to sell pipelines to KMP which might otherwise have gone to EPB. This means that EPB could lose some growth to KMP.

However, if that should happen, it means Kinder Morgan's growth will be greater than before. So the best strategy here is to own both Kinder Morgan and El Paso, or at least, don't buy El Paso without buying Kinder Morgan.

Finally, there's an aspect to MLPs that is both good and bad, though, and it involves taxes.

The bad is that tax regulations regarding MLPs are so complicated that when you invest in them you will probably require assistance in filing out your tax returns.

The good aspect is twofold. While you're dealing with those tax complications at the end of the year, you'll also be counting up your profits.

What's more, it's precisely because of those tax complications that many people don't go near these investment vehicles. As a result, these stocks are to some extent artificially cheap.

But given the potential for total returns that easily exceed 10%, we believe the tax complications are well worth it.

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Tags: EPBKMP
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