Master limited partnerships (MLPs) are entities that have chosen to structure as partnerships for tax purposes. As such, they pass through income to investors to avoid paying taxes at the corporate level. That enables investors to keep more of the income they produce. (Also see our investing guide, "How to Invest in MLP Stocks.")

MLPs, however, aren't without their pitfalls. For starters, there are tax issues with MLPs that can prevent investors from holding them in an IRA or 401(k). Further, many MLPs have delivered poor investment performances over the years because of a variety of problems, including mismanagement and the impact of oil price volatility -- most MLPs are in the energy sector because of the qualifying income limitations. Because of these factors, MLPs aren't for everyone.

However, MLPs can be great investment options for those seeking a tax-advantaged income stream as long as they choose ones that can maximize the benefits of the structure. This guide will walk investors through how to find the best MLPs. It will also take a closer look at five top options with enduring competitive advantages that make them excellent buys for the long term.

Oil pumps and storage tanks with the sun setting in the background.

Image source: Getty Images.

How to find the best MLPs

Several factors have caused many MLPs to underperform the market in recent years. The Alerian MLP ETF, which is an exchange-traded fund focused on MLPs, delivered a 26% total return during the 10 years from mid-July 2009 through mid-July 2019. The S&P 500, on the other hand, produced a 240% total return during that time frame.

A small group of MLPs, however, managed to outperform not only their peers but also the S&P 500 during that period. Several factors played a role in driving that outperformance. Here's a closer look at the five essential characteristics found in the best-performing MLPs.

  1. Predictable cash flow: The foundation of the top MLPs is the stability of their cash flow. This steadiness comes from long-term fixed-fee contracts and regulated rates. In most cases, predictable sources provided more than 80% of an MLP's cash flow.
  2. An investment-grade credit rating: Another calling card of the top MLPs is that they have a strong financial profile anchored by an investment-grade credit rating. That increases their access to borrowing money at cheaper rates.
  3. A low leverage ratio: This metric goes together with the credit rating, since it helps back up that view. Ideally, an MLP focused on the midstream oil and gas sector will have a debt-to-EBITDA ratio of less than 4.
  4. A conservative distribution coverage ratio: This metric measures how many times an MLP can cover its current distribution to investors with cash flow. Historically, the best MLPs aimed to cover their payout by 1.2 times. However, they've become much more conservative following the oil market downturn of 2014 through 2016. That market turmoil led many to raise their coverage targets to more than 1.5 times cash flow.
  5. A high-quality portfolio with visible growth prospects: The best MLPs operate top-notch assets in the best markets. That keeps them in high demand, which enables these MLPs to renew contracts at higher rates when they expire. Further, it also enhances an MLP's ability to expand its asset base so that it can meet growing customer demand.

The top MLPs to buy now

Many MLPs meet some of the above criteria. Few, however, have a proven history of maintaining top-level performance across the board over the years. That helps narrow the list of MLPs that are likely to outperform in the coming years. The top five are in the following table:

Top MLP Stocks to Buy

Focus Areas

Brookfield Infrastructure Partners (NYSE:BIP)

Energy, transportation, utility, and data infrastructure

Brookfield Renewable Partners (NYSE:BEP)

Renewable energy generation

Enterprise Products Partners (NYSE:EPD)

Natural gas liquids (NGLs) production, transportation, and storage

Magellan Midstream Partners (NYSE:MMP)

Refined petroleum products transportation and storage

Phillips 66 Partners (NYSE:MPLX)

Liquids transportation and storage

Data source: Company presentations.

This group has the best combination of characteristics and other enduring competitive advantages that make them great stocks to buy for the long term in almost any market condition. Here's a closer look at why they stand out as the top MLPs to buy.

A burst of sunlight shining on a pipeline.

Image source: Getty Images.

Brookfield Infrastructure Partners: The global infrastructure MLP

Brookfield Infrastructure is a partnership formed by leading Canadian asset manager Brookfield Asset Management (NYSE:BAM). It focuses on owning and operating high-quality, long-life infrastructure assets that provide essential products and services for the global economy. The company's portfolio spans five continents and focuses on infrastructure businesses in the utility, transportation, energy, and data sectors.

Brookfield Infrastructure's defining characteristics: The company's infrastructure portfolio generates predictable cash flow. In its fiscal 2019, long-term contracts or a regulatory framework supported 95% of its cash flow, with 60% having no volume risk. The company also boasted a solid investment-grade credit rating backed by low leverage metrics. Brookfield Infrastructure complements that strong balance sheet with a conservative coverage ratio that it targets to be in the range of 1.4 times to 1.67 times.

This combination of characteristics has enabled Brookfield Infrastructure to grow its funds from operations (FFO) per unit at a 16% compound annual rate in the decade from its formation in 2009 through 2019 via a combination of acquisitions and organic expansion projects. That consistent cash flow growth enabled Brookfield Infrastructure to increase its distribution at a 10% compound annual rate over that span. This steadily rising income stream helped Brookfield Infrastructure generate a 17% annualized total return over that decade, which was well ahead of the S&P 500's 9% annualized total return over that time.

Brookfield Infrastructure's upside potential: Brookfield Infrastructure has the resources to continue growing its FFO at a healthy rate over the next several years. The company estimates that cost-reduction initiatives, higher rates on its contracts as pricing improves, and organic expansion projects should grow its FFO per unit at a 6% to 9% annual rate through 2022. That should support 5% to 9% yearly distribution increases. Add that growth to the cash distribution, which typically yielded around 4.5%, and Brookfield Infrastructure could potentially generate total returns in the 10% to 14% annual range. That should be enough to beat the market, making it one of the top MLPs to buy.

Brookfield Renewable Partners: The renewable energy MLP

Brookfield Renewable is another partnership formed by Brookfield Asset Management. The company initially operated hydroelectric power plants but has since diversified into wind, solar, and energy storage assets. The renewable energy company takes a global approach, with operations in North and South America, Europe, and Asia.

Brookfield Renewable's defining characteristics: Brookfield Renewable sells the bulk of its power under long-term fixed-priced contracts. In 2019, those agreements locked in the rates for 87% of its anticipated power output. That lined up with its historical average of locking in the rates for at least 85% of its anticipated electricity production. The company further supports that predictable cash flow with a strong balance sheet. It has one of the highest credit ratings among renewable energy-focused companies, which it backs with conservative leverage metrics. The company further bolsters that strong financial profile by targeting a healthy distribution coverage ratio of 1.4 times.

Like its infrastructure-focused sibling, Brookfield Renewable's history of maintaining a sound financial profile has enabled it to steadily grow its cash flow. That allowed the company to increase its distribution at a 6% compound annual rate from 2012 through 2019. This steady growth gave Brookfield the power to generate a 16% total annualized return over that period, which easily outpaced the S&P 500's 6% total annualized return over that span.

Brookfield Renewable's upside potential: Brookfield Renewable estimates that its existing portfolio of assets can grow its cash flow at a 6% to 11% annual rate through 2022. The company sees about half of that growth coming from cost-reduction initiatives and its ability to secure higher power prices as existing contracts expire. The other half will come from building new renewable power assets. That forecast supports the company's plan to increase its distribution to investors at a 5% to 9% annual rate over that stretch. Add the payout -- which yielded an average of around 6% over the five-year period from 2014 to 2019 -- to its growth rate, and Brookfield Renewable could generate total annual returns in the 10% to 15% range.

Enterprise Products Partners: The NGL-focused MLP

Enterprise Products Partners operates one of the largest integrated midstream footprints in North America. The company's portfolio includes natural gas, oil, NGLs, refined products, petrochemical pipelines, processing plants, storage facilities, and export terminals. However, its biggest moneymaker is NGLs, which supplied 50% of its earnings in 2018.

Enterprise Products' defining characteristics: Enterprise Products Partners earns fees as energy passes through its network of assets, so fee-based agreements typically supply more than 85% of Enterprise's earnings each year. The company pairs its steady cash flow with one of the highest credit ratings among MLPs, which is backed with a leverage ratio that has traditionally been less than 4.0 times. Meanwhile, the company has aimed to keep its distribution coverage ratio at or above 1.2 times, with it typically averaging more than 1.5 times each year.

The MLP's conservative financial profile has given it the flexibility to invest in acquisitions and expansion projects that have consistently grown its cash flow. In the two decades following its initial public offering (IPO) in 1998, the company has invested $42 billion on organic growth projects and spent another $26 billion on acquisitions. Those two growth drivers enabled the company to increase its distribution for 20 consecutive years. That has given Enterprise Products Partners the fuel to significantly outperform the S&P 500. From its IPO in 1998 through the middle of 2019, the company produced a more than 2,000% total return, which crushed the nearly 300% total return of the S&P 500.

Enterprise Products' upside potential: Enterprise Products Partners had $5 billion of growth projects under construction as of the middle of 2019 and another $5 billion to $10 billion of expansions in development. Those growth projects span energy commodities and should enable the company to continue growing its cash flow per unit at a mid-single-digit annual rate for several years. Meanwhile, with the midstream industry needing to invest more than $800 billion on new infrastructure through 2035, including $50 billion alone on NGL-related assets, the company should have plenty of growth opportunities. Add that growth to the company's distribution, which yielded more than 6% on average in the five-year period from 2014 through 2019, and Enterprise Products Partners could generate total annual returns in the double digits.

Pipelines laid out for construction at sunset.

Image source: Getty Images.

Magellan Midstream Partners: The refined-products-focused MLP

Magellan Midstream operates the longest refined-petroleum-products pipeline system in the U.S., which is primarily focused on transporting gasoline and diesel from refineries to market centers. In addition to that, the company owns interests in several crude oil pipelines and operates a marine storage business. In 2018, refined-products services supplied 59% of its earnings, followed by 34% from crude oil and 7% from marine storage.

Magellan Midstream's defining characteristics: Long-term fee-based contracts typically support more than 85% of Magellan Midstream's annual earnings. Meanwhile, the company boasts one of the highest credit ratings among MLPs, backed by a leverage ratio that has traditionally been well below 4.0 times debt-to-EBITDA. The company also has historically had an above-average distribution coverage ratio of at least 1.2 times.

Magellan Midstream has leveraged its strong financial profile to continue expanding its operations through acquisitions as well as organic expansion projects. Those growth-focused initiatives have increased the company's cash flow so that it has been able to boost its distribution at a 12% compound annual rate since its IPO in 2001. That growing income stream has given Magellan Midstream the fuel to trounce the market since its formation. Through the middle of 2019, the MLP has generated a total return of more than 3,000%, which has obliterated the 220% total return of the S&P 500.

Magellan Midstream's upside potential: Magellan Midstream had $1.25 billion of growth projects under construction as of the middle of 2019, with more than $500 million of potential expansions under development. Those projects, along with the others it will likely secure in the coming years, should give the company the fuel to continue increasing both its cash flow and its distribution. If the company can expand its cash flow and payout -- which yielded an average of about 5% during the five-year period from 2014 to 2019 -- at a 5% annual pace in the future (its targeted growth rate in 2019), that could support 10% total annual returns for investors.

Phillips 66 Partners: The refinery logistics MLP

Downstream oil and gas company Phillips 66 (NYSE:PSX) created its namesake MLP in 2013. Its mission is to own, operate, develop, and acquire primarily fee-based midstream infrastructure focused on oil, refined products, and NGLs. Phillips 66 initially grew its MLP by dropping down its logistics assets. However, as Phillips 66 Partners has increased its scale, it has diversified its growth drivers to include third-party acquisitions and organic expansion projects.

Phillips 66 Partners' defining characteristics: Long-term, fee-based contracts with Phillips 66 and other customers supply nearly all of Phillips 66 Partners' earnings. The company complements its predictable cash flow with a solid investment-grade credit rating that it backs with a leverage ratio that was below 3.0 times in mid-2019. Meanwhile, the company's coverage ratio has typically been above 1.3 times.

Phillips 66 built its MLP to deliver high-octane growth fueled by drop-down acquisitions. From its IPO in late 2013 through the end of 2018, the MLP expanded its distribution at a gaudy 30% compound annual rate, which achieved Phillips 66's target. That fast-growing payout has helped Phillips 66 Partners outperform the market throughout its history. Overall, from its IPO through the middle of 2019, the MLP generated a total return of 115%, which beat the S&P 500's 101% total return over that time.

Phillips 66 Partners' upside potential: Phillips 66 Partners isn't likely going to continue growing its distribution at a 30% clip in the future. However, the MLP should still be able to expand at a healthy pace in the coming years. For starters, it has an excellent financial profile, which gives it the funding flexibility to pursue expansion projects as well as acquisitions. The company had several large-scale growth projects under construction as of the middle of 2019, which should fuel growth well into the next decade. Phillips 66 also had several pipeline projects under development that it could eventually build within its MLP. Add to that the need for nearly $375 billion of liquids-related infrastructure through 2035, and this MLP is well positioned to continue expanding. Given its average 5%-yielding distribution during the five-year period from 2014 to 2019, Phillips 66 Partners potentially only needs to grow its cash flow per unit at a mid-single-digit rate to deliver double-digit total annual returns.

The best MLPs boast two top qualities

First, each of the best MLPs has a top-tier financial profile, which includes generating stable cash flow, having a strong balance sheet, and maintaining a conservative coverage ratio. Second, they combine that financial strength with a strong strategic asset footprint, which gives them the ability to continue expanding their cash flow and distribution. Those factors should enable these MLPs to continue outperforming not only their peers but also the broader market. That's why they're the best ones to buy right now.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.