The 2 Best Upstream MLPs Are on Sale Now
Casey is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The latest correction in stocks has been caused by rising bond yields. As 10-year Treasury notes have gone from 1.6% to 2.5%, many dividend paying, slow growth stocks have been hit the hardest. For many, it just doesn't make sense to hold them with these higher bond rates.
One group hit very hard has been the upstream MLPs. Upstream MLPs are oil and gas producers which enjoy the benefits of incorporation but are taxed as a partnership, meaning they don't pay corporate taxes. By their very nature as partnerships, upstream MLPs distribute lots of cash to unit holders.
Upstream MLPs usually carry a high debt load and are involved in the business of oil and gas production. And because of this, they are considered more risky. But with this risk comes a very high cash distribution yield.
In this article, I will highlight the two best-in-class upstream MLPs. While this business does indeed come with risk, these two have done a great job in mitigating that risk and ensuring stable, predictable cash flows. With this correction, both of them are trading near their lows.
The original and still the best
Linn Energy (NASDAQ: LINE) was one of the first upstream MLPs and is easily the largest. Their strategy is one emulated by many others: buy older, mature fields which require no further exploration, squeeze out every bit of oil and gas over the field's long life, and lock in the price of that oil and gas through hedges for multiple years out.
Linn is a controversial stock. Attacked by Barron's for its hedging strategy, management has since addressed those concerns directly. Rumors abound that short sellers are attempting to disrupt their acquisition of Berry Petroleum (NYSE: BRY). The Berry acquisition, which is not yet completed, will be the lynchpin of Linn's growth strategy going forward: Berry has lots of oil assets, including some premium acreage in California which Linn will use to grow production. Some believe that short sellers are trying to knock down the share price enough so that Berry shareholders will walk away from this all-stock transaction.
The case for Linn is this: It hedges 100% of its production four years out. Its cash flow is already locked in. More than that, management has an excellent history with hedging, largely avoiding the collapse of natural gas prices in '08-09. Linn also tends to get the best acquisitions, nabbing up land from BP in several deals after the Macondo oil spill. And thus far, everything we've heard from both Berry and Linn suggest that the transaction will go through.
Trading at only 10.67 times Distributable Cash Flow (DCF) and with a dividend yield of 8.75%, Linn is cheap. Its dividend yield is as high as it's been in nearly three years. Now is a fine time to pick up this best-of-breed MLP.
The contrarian MLP
If Linn is the first and biggest, then Vanguard Natural Resources (NASDAQ: VNR) is marching to the beat of its own drum. Like many MLPs, Vanguard has been actively acquiring over the last few years. But most other energy producers have gone after oil assets. Vanguard has embraced a contrarian strategy, scooping up the natural gas assets that other companies are practically giving away at low multiples.
Vanguard and Linn are different in a few important ways. In some ways, Vanguard is the more conservative company. Vanguard enjoys a lower debt-to-market cap than Linn. And while Linn's hedges are more extensive than Vanguard's, it is less costly for Vanguard to hedge its gas production. Because many of its new assets were purchased at such low prices, Vanguard can still meet its obligations with natural gas prices as low as $2, and oil as low as $70 per barrel.
Vanguard now yields 8.8% and sells at only 10.1 times DCF: just as cheap as Linn. And Vanguard has one other advantage: it is not under attack from short sellers. In fact, the stock price has been very stable compared to Linn's ups-and-downs. It pays to fly under the radar sometimes.
Upstream MLPs are not for everyone. They are levered higher than blue-chip dividend payers and are exposed to oil and gas prices. Both Linn and Vanguard, however, have mitigated this risk through hedging and acquiring already proven fields. Cash flow is visible for several years out on both. For these reasons, Vanguard and Linn are a good well for income investors to draw from.
Casey Hoerth is long LINE. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!