High Income, Low Price

11/26/2008 11:00 am EST

Focus: FUNDS

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Elliott Gue, editor of The Energy Strategist, says master limited partnerships offer good value, and he recommends one in particular.

Master Limited Partnerships (MLP) have been bloodied in recent months due mainly to forced liquidations by hedge funds and other institutional investors. Meanwhile, the vast majority are actually increasing their distribution payouts.

MLPs currently offer high-yield potential for investors, which is the big advantage of this asset class. In addition, MLPs are partnerships, not corporations, so these firms pay no corporate-level tax whatsoever.

The most common assets owned by MLPs are oil and gas pipelines, [which typically have] little or no real exposure to commodity prices. This is one of the steadiest, most cash-flow-positive businesses you'll encounter.

The distributions aren’t taxed as dividends; instead, part of each distribution is taxed as a return of capital (ROC), while the remainder is taxed as regular income and will be taxed at normal income tax rates.

Effectively, thanks to return of capital payments, you can defer paying taxes on most of your distributions from MLPs for many years, if not indefinitely. One caveat: It's best to hold MLPs in taxable accounts rather than [retirement] accounts.

And MLPs are currently offering attractive yields relative to other income-producing securities. This dramatic increase in risk premiums makes no sense. Most of the MLPs I follow have ample debt capital available to fund their near-term expansion plans without having to sell more bonds or take out new credit lines with banks.

Furthermore, as the credit crisis continues to ease, these spreads should revert to levels closer to their long-term averages. I consider [this] the best buying opportunity of the decade for income-oriented investors.

Enterprise Products Partners (NYSE: EPD) is one of the largest and oldest MLPs in the US. The MLP focuses primarily on assets related to natural gas.

Some of Enterprise’s key assets include onshore and offshore gas pipelines, a series of floating production platforms in the Gulf of Mexico, natural gas processing, and fractionating facilities for removing natural gas liquids (NGLs) from the gas stream and NGL pipelines. And Enterprise does have some impressive and attractive organic growth projects under way that will add to [distributable cash flow] in coming quarters.

Barring a major improvement in capital market conditions over the next 12 months, I’d expect Enterprise to grow its distributions by roughly 5.5% to 6.5% year over year in 2009. (In 26 out of the past 39 quarters, Enterprise has raised its payout.) And Enterprise appears to have scaled back its growth capital-spending program. The MLP is focusing only on the most profitable and assured prospects that it can finance without issuing more bonds or stock.

Enterprise has little real exposure to credit market conditions at least into early 2010. Due to the stock’s defensive characteristics, Enterprise offers a slightly lower-than-average yield of 8.5% to 9%. But its unblemished record of boosting distributions, attractive financing position, and ongoing organic projects, EPD is a buy. (It closed at $19.49 Tuesday—Editor.)

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