Attractive MLPs Are Everywhere

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Ongoing fear of higher interest rates resulting from tapering by the Federal Reserve, whereby our central bank would wind down its policy of aggressive bond purchases, has served as a major drag on certain market sectors over the past few weeks.

One sector being hit particularly hard on the possibility of higher interest rates in the near future is the energy sector, and more specifically, oil and gas Master Limited Partnerships. MLPs, as they are more commonly referred to, enjoy a favorable tax treatment in exchange for paying out the vast majority of their profits as distributions to unitholders. As a result, MLPs have historically been among the market’s higher-yielding securities.

In that sense, MLPs are presently suffering right alongside bonds, as investors appear willing to ditch anything with yield. But investors are missing a key point that separates the two asset classes, and that tells me investors are missing out on a compelling buying opportunity.

Two industry stalwarts

Kinder Morgan Energy Partners (NYSE: KMP) is a $32 billion oil and gas MLP, and operates 75,000 miles of pipelines and 180 terminals. The company’s pipelines transport products including natural gas, refined petroleum products, and crude oil.

Kinder Morgan units have declined 10% just since April 23.

Similarly, Linn Energy (NASDAQ: LINE) engages in the acquisition and development of oil and natural gas. As of the beginning of 2013, it had proven reserves of nearly 5,000 billion cubic feet equivalent of oil, natural gas, and natural gas liquids, and operated nearly 16,000 wells.

An interesting way to gain access to Linn’s hefty payout without the hassles of the K-1 is via LinnCo (NASDAQ: LNCO), which is essentially a holding company for Linn and has the same $3.08 payout as Linn units.

Both Kinder Morgan and Linn Energy are high-yielders that are seeing their units decline along with fixed income securities. Kinder Morgan now yields 6.20%, LinnCo pays 8.30% and Linn Energy surpasses them both with a 9.30% yield at recent prices.

The key point: Stocks are not bonds

As the saying goes, all things must come to an end. The Federal Reserve’s long-held policy of low interest rates and aggressive bond buying, while certainly a major contributor to rising asset prices since the Great Recession, cannot last forever.

That’s a good thing, bear in mind, because the Fed has maintained it would only taper off its bond purchases if it believed the economy could finally stand on its own legs.

And remember, investors, that MLPs are not bonds. Stocks, including MLPs, are pass-through securities that will handle higher interest rates much better than bonds.

First, should the economy prove to be strong enough for the Fed to take its foot off the monetary pedal, a stronger economy would certainly involve greater demand for the natural resources transported by America’s best MLPs. That means higher profits for unit holders, and assuming you bought at opportune prices (like now), higher stock prices.

Second, higher profits mean higher distributions for these MLPs, another key difference between stocks and bonds. Bonds are contractual relationships that carry a fixed coupon throughout the life of the bond (hence the term fixed income). MLPs, such as Linn Energy and Kinder Morgan, on the other hand, raise their distributions over time as their profits grow.

To that end, Kinder Morgan has raised its distribution steadily for many years, with its most recent quarterly payout being 8% higher than the same payout last year. Going back further, Kinder Morgan has raised its distribution by 6.25% compounded annually over the past five years.

Linn Energy, meanwhile, announced it would up its distribution from $2.90 to $3.08 later this year, on both Linn Energy and LinnCo, amounting to a 6.2% increase from the previous distribution. Moreover, the company also announced its intention to pay its distribution monthly instead of quarterly, meaning investors can compound their wealth even faster.

Linn and Kinder Morgan: The definition of slow-and-steady wealth creation

I’ve initiated a position in LinnCo and would eagerly buy more should the opportunity arise. I’ll gladly lower my cost basis and secure an even higher yield should the often-irrational Mr. Market decide it would rather put its money in cash yielding 1% than LinnCo at 8%.

Same for Kinder Morgan: while I do not have a position yet, I’m strongly considering allocating spare capital to what represents one of the best-run MLPs in existence.

As a result, I view the recent downturns among these oil and gas MLPs not as threats, but as welcome buying opportunities.

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Robert Ciura owns shares of Linn Co, LLC . 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!

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