Best MLPs

MLPs or Master Limited Partnerships are a must have in every portfolio.

Not only do MLPs pay some of the highest yields in today's market, they are also a great way for investors to ride America's energy boom to profits.

These are companies in the middle of the oil and gas supply chain, and are an integral part of America's transformation into a net exporter of energy rather than importer.

MLPs provide critical services in transportation, storage, and refining, connecting energy producers to the end-users all across the world.

In addition to their high yields, MLPs also benefit from inflation, as the price of oil rises. But the best thing about MLPs is that they give you a way to earn high yields, double-digit returns... and pay lower taxes.

The overall effect is dramatic.

First, there are the hefty "distributions" MLPs payout year after year. Several of the 50 companies in the benchmark Alerian MLP Index offer yields of 7% or higher.

Second, there's price appreciation. MLPs have been outperforming the market for years. Since January 2007 the Alerian MLP Index has a total return of 75.87%, more than double the 35.64% return of the record-setting S&P 500 over the same time.

It's a fact: This is the best source for higher-than-average yields and the best opportunity for share appreciation as demand and supply of energy both continue to rise.

And today, we'll look at the best shares this lucrative sector offers. But first, let's look at what makes MLPs so appealing in the first place.

Better Than Dividends

Due to an obscure law passed during the Reagan era, companies that service the oil and energy sector are allowed to funnel profits directly to their investors.

Unlike dividends, the majority of income investors get from MLPs is not taxed when they are received; instead, it's considered reductions in the investment's cost basis and creates a tax liability that is deferred until the MLP is sold.

And because of this unique tax loophole, investors who hold MLPs for the long term can completely avoid paying taxes on 80%-90% of the distributions they receive.

MLPs trade on exchanges just like common shares of stock.

A key difference between MLPs and most stocks is that U.S. law mandates MLPs pass most of their income on to unit holders.

Still, being limited partnerships, their ordinary shareholders do not suffer unlimited liability (as they would in a regular partnership) and so can treat their investment as if it was in an ordinary company.

However, because their income is not taxed at the partnership level, the government limits the kinds of businesses that can use the MLP structure.

It's restricted primarily to operations engaged in the extraction, storage, and transportation of energy commodities, which are deemed essential to the U.S. economy and national security.

As a result, MLPs derive 90% of their income from natural resources - primarily oil, natural gas, and coal production and transportation.

Two especially attractive businesses for the MLP structure are pipelines and ownership of existing oil resources.

Pipelines generally charge a fixed fee per unit of product carried, so they earn a steady return that can safely be paid out to investors.

Existing oil and gas fields incur no exploration costs and only limited production costs. Meanwhile, their exposure to oil and gas prices can be hedged in the futures market, so they, too, can safely pay a fixed dividend to investors.

MLPs economically bear more resemblance to fixed income investments than to regular shares.

And getting the best return out of this high-yielding sector requires a bit of finesse.

How to Beat the S&P by 243%

Like any investment, better understanding the risks associated with MLPs will lead to higher returns-the kind of returns that crush traditional blue-chips.

MLPs by nature are subject to price sensitivity to the underlying natural resource, be it oil, gas, coal, or another commodity.

The impact is typically not as severe for MLPs, as it is with some energy companies, since energy products still have to be shipped, providing steady revenue for pipeline and transport companies, regardless of the price of oil.

Additionally, if the MLP is invested in a finite pool of oil or gas, there is a finite lifetime to it, and the income to investors may be accompanied by a gradual loss of principal. Fortunately, MLP tax treatment accounts for this, and so a large portion of each year's dividends is considered a return of principal. That may have advantages to some investors holding MLPs in taxable accounts.

Just keep one thing in mind when you do your analysis:

With regular dividend-paying stocks, it's important to review the corporate earnings, earnings-per-share (EPS) and cash-reserve numbers to ensure the company has the funds needed to "cover" the dividend payout.

With MLPs you'll frequently see stated EPS numbers that are well below the payout level - or even negative.

Remember, however, that the quarterly-required distributions are deducted before earnings, if any, are calculated, so the EPS numbers are not as relevant.

Overall, MLPs are generally not very risky for the yield and growth that accompany them, and out of the two exchange-traded funds (ETFs) that invest in them - the Alerian MLP ETF (NYSE: AMLP) and JP Morgan Alerian MLP Index ETN (NYSE: AMJ) - we like AMJ and its 4.8% dividend better.

And we like these MLPs the best...

Buy-Rated MLP #1

Cheniere Energy Partners L.P. (NYSE: CQP)

Cheniere Energy is going to be the leader in exporting LNG to a waiting global market, and CQP is the MLP that controls its Sabine Pass LNG terminal on the Louisiana-Texas border.

CQP currently offers a 5.15% dividend, as well as the potential for triple-digit returns. In fact, there are plenty of catalysts that could ignite this stock...again.

Cheniere was the first company to win approval from the Energy Department to ship LNG out of the U.S. and the company is set up for long-term success.

So far Cheniere has secured seven 20-year, mega-billion dollar contracts with some of the largest LNG importers worldwide and has deals to ship to the U.K, South Korea, India, Spain and France.

Cheniere's run has been impressive the past few years, but long-term investors know the profits haven't even begun to roll in.

Once Cheniere begins exporting LNG, which should begin in 2015, things will get really exciting for the company...and its investors.

Buy-Rated MLP #2

Enbridge Energy Partners L.P. (NYSE: EEP)

Enbridge will be a growth machine as it unleashes a game-changing pipeline expansion program.

It's a play on the Bakken, Canadian oil sands, and has an outstanding history. Enbridge has consistently raised its dividend since 1992 and currently yields 7.51%.

The company owns and operates 11,500 natural gas transportation lines, approximately 6,500 miles of crude oil transportation lines and 32 million barrels of storage capacity-including oil pipelines that bring Canadian crude down to the United States and gas pipelines woven throughout East and North Texas - as well as natural gas storage and processing facilities. 

The Seaway Pipeline is now moving crude oil from the bottle-necked Cushing, OK hub to the vast refinery complex along the Gulf Coast. Seaway's capacity is expected to more than double to 850,000 BPD in the first half of 2014, when expansions are complete.

Another $6.2 billion project aims to move crude from the Canadian oil sands and the Bakken to refineries in the United States, adding 400,000 bpd by 2016.

Buy-Rated MLP #3

Teekay LNG Partners L.P. (NYSE: TGP)

Teekay is the third- largest independent owner of LNG ships in the world and yields 6.37%.

Founded in 2004 in Bermuda, TGP provides transportation services for LNG, LPG (liquefied petroleum gas), and crude oil.

Today the company boasts 27 LNG carriers, five LPG carriers, and 11 oil tankers, all of which operate under long-term, fixed-rate time-charter contracts with large energy and utility companies.

These contracts typically run between 10 and 25 years in length, so they generate nice and stable cash flows.

Teekay will profit handsomely from the surging wave of LNG already making its way into Europe and especially Asia.

In Japan LNG carriers are in heavy demand after the nuclear power problems led to permanent shutdowns of nuclear power stations.

And in China LNG imports have grown 23% on average the past two years.

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