These Are the 2 Best Oil and Gas MLPs in America

As part of a series exploring the entire upstream (exploration and production) MLP industry, I've been advising investors to consider four important metrics when deciding which MLPs to invest in: yield, distribution growth, distribution security, and valuation. I now realize there is a fifth variable that is also important to keep in mind -- volatility. 

A 2011 Harvard study found that lower-volatility stocks outperform higher-volatility securities over the long term. 

In addition, higher-yielding securities outperform lower-yielding securities. For example, between 1968 and 2007, the the top 100 yielding S&P 500 companies outperformed the total index by 28.4% annually.

Distribution growth is likewise important for total returns. Between 1972 and 2004, those S&P 500 stocks that raised their dividends posted 24.6% better annual performance than the S&P 500 at large, and 122% better than those that didn't pay dividends at all. 

Distribution security, in the form of the 12-month coverage ratio, is vitally important to tell investors whether the current yield is safe and likely to grow. 

Finally, valuation is important because overpaying for securities can lower long-term total returns. I like the EV/EBITDA ratio as a means of comparing MLPs because it takes into account cash on hand, debt, and cash flows: all vitally important in this capital-intensive industry. 

Using these five metrics, I've screened the entire upstream MLP industry and found what I believe to be the two best MLPs in the country: Breitburn Energy Partners (NASDAQ: BBEP  ) and New Source Energy Partners (NYSE: NSLP  ) .

Industry best metrics

MLP Yield 10-Year Projected Distribution Growth Rate 12 Month Coverage Ratio EV/EBITDA Beta 10-Year Annual Projected Total Return
New Source Energy Partners  9.9% 27.06% 1.42 14.55 0.37 35.54%
Breitburn Energy Partners  9.1% 35.46% 1.11 12.24 0.67 44.56%
IND AVG 9.63% 9.40% 1.05 12.37 0.74 19.03%

Sources: S&P Capital IQ, Yahoo! Finance, MLPdata.com.

Breitburn Energy Partners has always been one of my favorite oil and gas producers, but not until I did this industrywide comparison did its potential become apparent. With a generous yield, low volatility, a coverage ratio that is tied for second best in the industry, and analysts projecting staggering growth over the next decade, Breitburn Energy Partners exemplifies one of the best energy investments in America. The key to Breitburn's success is its approach to expansion and production maintenance. 

First, Breitburn Energy Partners is a master of accretive acquisitions -- $2.1 billion worth from 2011-2013.

Its 15-person acquisition team is careful to ensure that any purchased assets are low decline and immediately accretive to existing unit holders. For example, in 2013, Breitburn analyzed 400 potential acquisition targets before making two purchases for $1.2 billion.

The result of its purchases has been 113% growth of proven reserves, including 72% growth in high-margin liquids (oil and natural gas liquids). 

With $773 million in liquidity and management targeting $600 million in acquisitions this year, Breitburn's growth is set to continue, but what makes Breitburn one of the top MLPs in its industry are the assets it's targeting and its use of enhanced oil recovery techniques. 

Breitburn's $860 million Oklahoma oil field purchase included 29,357 net acres of oil rich land and plenty of infrastructure, including an oil pipeline, gas processing plant, and CO2 pipeline that allows for enhanced oil recovery (CO2 injection into wells to maintain pressure). This results in little to no production decline and will greatly help Breitburn Energy Partners grow its distribution in the future.

Breitburn is also aggressively hunting for new oil-rich resources in the Permian Basin -- an area estimated to hold 75 billion barrels of oil that costs just $7/barrel to extract.

Coupled with aggressive hedging through 2018, Breitburn Energy Partners' cash flows and distribution growth are expected to accelerate for years to come.

New Source Energy Partners is the smallest and newest upstream MLP, having IPOed in 2013, and it drills out of the Hunton formation of central Oklahoma, where it owns 20.6 million barrels of reserves -- 71% high-margin liquids.

New Source Energy Partners has grown its reserves (45%) and production (44%) in just one year through a series of six oil and gas acquisitions, but what makes it a unique MLP opportunity is its oil services business. In November of 2013, New Source Energy began purchasing oil service companies. To date, its four acquisitions total $160.8 million and its oil services operations include the Permian, Eagle Ford, and Marcellus/Utica shales, with plans to expand into the Bakken.

The fast-growing oil services business is expected to bring in $170 million in revenue in 2015 at an EBITDA margin of 25%-29%, and grow revenues by 369% from 2013 to 2015.

Finally, investors should be aware that although it's a new upstream MLP, New Source Energy has one of the best management teams in the industry:

  • 29 year track record drilling in Hunton, 98% success rate
  • 37.9% net margin vs 9.6% industry average
  • 12.9% return on assets vs 3.5% industry average
  • 24.2% return on equity vs 7.6% industry average 

Foolish takeaway
Upstream MLPs are one of the best ways for long-term income investors to cash in on America's record-smashing energy boom. Breitburn Energy Partners and New Source Energy Partners represent the best of the industry when it comes to all the major factors that affect long-term total returns. With low volatility and secure, generous yields that are expected to grow quickly, Breitburn Energy and New Source Energy have the potential to be two of the best-performing investments of the next decade.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 11, 2014, at 10:17 PM, ThomasOil wrote:

    Issues of upstream MLP is that their revenue depend on the commodity price, declining rate of production, and drilling risks (may hit dry holes). Thus midstream MLPs are preferred as the revenue is fee based. So, why are these two best MLPs?

  • Report this Comment On July 12, 2014, at 6:44 PM, AdamGalas wrote:

    These are the two Upstream MLPs in America.

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