Energy: Pump and Deliver

08/22/2003 12:00 am EST


Neil George

Editor-in-Chief, Income Publication and Products, Agora Financial

In addition to his role as editor of The Utility Forecaster, Roger Conrad is responsible for the income portfolio at Personal Finance.  Among his favorite areas now for safety and yield are limited partnerships that serve the energy industry, through their ownership of pipelines and storage facilities. Here are his top picks.

"Our limited partnership recommendations trade just like common stocks and pay an average dividend of 7%-plus that was hiked 4.3% last year. Best of all, they make their cash from fees paid by the energy giants who use their networks to ship and store energy. The fees are paid whether oil is at $100 a barrel or $10, and they automatically flow to tax-advantaged dividends for shareholders. And all seven LPs are financially strong, giving them the wherewithal to raise more capital for expansion and growth. The core asset of each is a gas/oil pipeline/storage network generating a river of cash from usage fees.

"Buckeye Partners (BPL NYSE) owns 5,000 miles of pipelines and storage facilities for refined petroleum products serving heavily populated areas in 10 Northeastern states, as well as Nevada and California. GulfTerra Partners (GTM NYSE), formerly El Paso Energy Partners, owns a network of offshore and onshore oil and gas pipelines and facilities in the Gulf of Mexico region, as well as natural gas liquids infrastructure in Mississippi, Louisiana, and Texas. Kaneb Pipeline Partners (KPP NYSE) has 3,000-plus miles of oil products pipe and related storage assets, which span seven states in the upper Midwest. The LP also owns a 2,000-mile anhydrous ammonia pipeline, which is critical to the fertilizer industry in this heavily agricultural area. Northern Border Pipelines (NBP NYSE) has as its main asset the key 1,249-mile pipeline linking the abundant gas reserves of Saskatchewan, Canada, to the energy-hungry Midwest. Robust demand for that line's capacity was proven once again by the ease with which the LP replaced the business of bankrupt Mirant Corp. last month. Plains All-American Pipeline (PAA NYSE) is a bit more aggressively run than the other LPs on our list, due to its marketing operations and penchant for acquisitions. The vast majority of LP cash, however, is drawn from leasing out capacity on its transportation and storage network, the primary catalyst for an expectation-topping 13.5% jump in second-quarter net income. Sunoco Partners (SXL NYSE) derives 63% of its cash flow from the business of GP Sunoco, from which it was spun off in 2001. But its pipes network of some 7,000 miles with related petroleum products storage facilities should be in high demand even in the unlikely event the GP fails to hold up its end. Petroleum product transportation and storage is also the specialty of TEPPCO Partners (TPP NYSE), jointly operated by GPs Duke Energy and ConocoPhillips. The LP is also building a presence in natural gas liquids infrastructure. Both operations were big winners in the second quarter.

"Valuation is the primary concern for these LPs. All boast high yields with growth potential. And as long as the economy is sluggish, their prices will rise in tandem with their dividend increases. That should translate into annual total returns of at least 10% for each. The catch is if you buy much above current prices, your returns will be less. You may have to wait a while to get the prices in parentheses. But patience will pay off. The closer you stick to them, the better the result will be: Buckeye (37), GulfTerra (35), Kaneb (44), Northern Border (44), Plains (33), Sunoco (33), TEPPCO (35)."

Neil George also has some favorites among high-yielding energy firms. At his Atlantic City Money Show seminar he notes, " We like a group of Canadian energy trusts that can simply pump and deliver petroleum products--both up and down stream. These companies generate very high levels of cash and are very focused on shareholders. The dividend yields on these trusts are typically in the low- to mid-double digits. In analyzing this universe of companies, I took a look at their cost of production and how they fared during the bad times for gas and oil. We found that even at $15 a barrel for oil and $2 per BTU for gas, these firms will be quite content and continue to generate nice profits.

"First on our list is Enerplus Resources Fund (ERF NYSE), which keeps pumping profits regardless of market conditions--more than 24% in principal and dividends on average during the past five years. And along the way, its dividend yield--even in the dark times of cheaper oil--remained nicely in the double digits. And you won't have to pay too high a premium for the underlying assets; it's valued at just 1.6 times book. Buy up to 27.  Another of the plain-and-simple gas and oil companies is Bonterra Energy (BNEUF NADAQ). It's a little more expensive than Enerplus but it's justified by its performance, climbing by more than 400% during the past five years. That's on top of dividend flows, which combined, have been providing double the average annual total return for investors of Enerplus. The dividend yield is as fat at nearly 13% but it's a bit more erratic in its heft. Bonterra is a buy ideally below eight but no more than 10. Another of the more expensive but consistent performers in the business is Advantage Energy (AVNNF NASDAQ). It's kept performing for its investors through the darker days of cheap petrol as well as recent boom times. But while it's more expensive than its peers, investors keep getting paid 17% dividends that should remain in the double digits, even if petrol prices head south. Buy Advantage Energy below 13. Next up is a company that expanded beyond just pumping known fields. It got a little adventurous and funded some more risky exploration at peril to shareholders. But after its restructuring and disposition of the riskier wildcatting in the oil and natural gas patches, Vermilion Energy Trust (VETMF NASDDAQ) should return to its roots of pumping and collecting cash. Buy Vermilion up to 11."

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