This article is part of a series on upstream MLPs in which I analyze the 11 largest oil and gas producers and compare them based on four key metrics: Yield, expected distribution growth, distribution security and valuation.
Yield and distribution growth represent the likely total return of MLPs over the long-term. Distribution security is vital for protecting one's capital and preserving income, which is the entire point of owning these securities. Finally, valuation, in the form of EV/EBITDA is a great way to make sure one isn't overpaying for one's investments, which can lower total returns over time.
This article highlights two little-known oil and gas producers who have the safest distributions in the industry and are poised to deliver superior income and total returns for many years to come.
| MLP | Yield | 10 year Projected Distribution Growth Rate | 12 Month Coverage Ratio | EV/EBITDA | Projected 10 Year Total Return |
| Legacy Reserves | 7.70% | 4.36% | 1.11 | 10.12 | 12.06% |
| Mid-Con Energy Partners | 9.20% | 3.74% | 1.16 | 13.02 | 12.94% |
| IND AVG | 9.65% | 7.79% | 1.01 | 12.17 | 17.44% |
Sources: S&P Capital IQ, Yahoo Finance, MLPdata.com
At first glance these two MLPs might not appear so hot. After all, they have lower yields than the industry average and much lower expected total returns and distribution growth. However, those growth projections are skewed by the three fastest-growing upstream MLPs (to be covered in another article), and removing their growth rates results in an average distribution growth rate of 2.46% and average expected total return of 12.01%.
What's more, these MLPs' distribution coverage ratios are the highest in the industry, making them among the safest high-yielding income investments in America. However, during the course of my research I discovered many more reasons income investors should consider Mid-Con Energy Partners (MCEP +0.00%) and Legacy Reserves (LGCY +0.00%).
Lowest-cost producer
Mid-Con Energy Partners is a small, Oklahoma-focused oil pure play with a twist. It injects high-pressure water into its fields to increase pressure and generate the highest margins in the industry.
- $25.15/barrel production cost compared to the $35-$45/barrel cost of CO2 injected fields and $50-$65/barrel cost of shale oil fields.
- $64.63/barrel EBITDA margin.
- Net margin of 31.2% vs 9.2% industry average.
- Return on assets of 12.7% vs 3.3% industry average.
- Return on equity of 29.1% vs 7.1% industry average.
That last metric, return on equity, is very important because it means that Mid-Con Energy can sell additional units to make accretive acquisitions. Its 9.3% yield means that it's essentially borrowing at 9.3% to gain a return of 29.1%. Since its 2011 IPO, Mid-Con Energy has made seven purchases and grown its production by 10.7% annually.
Management maintains strict discipline when it comes to not overpaying for these acquisitions, with the last two made for 5.6 and 2.9 times annual cash flows.
In addition to the highest operating efficiencies and margins in the industry, Mid-Con Energy also has one of the strongest balance sheets with a debt/EBITDA ratio of just 2.42 which management plans to lower under 2.0.
Mid-Con Energy is guiding for 4% distribution growth this year and distribution coverage of 1.2. This level of distribution growth, along with an already generous and highly secure 9.3% yield should put this MLP on any income investor's radar.
Legacy Reserves: financial innovator
Legacy Reserves is a diversified oil and gas producer whose assets are 47% oil, 46% gas, and 8% gas liquids.
The key to Legacy Reserves' success has been its seven-year track record of 131 acquisitions worth $2.1 billion. This has allowed Legacy to accrue not only the second highest coverage ratio in the industry but also grow production and EBITDA by 25% annually and raise distributions for 14 consecutive quarters.
What excites me about this MLP is Legacy's innovative use of incentive distribution rights (IDRs) as currency in its recent deal with WPX Energy (WPX +0.00%). Legacy acquired a 29% working interest in 2,730 WPX gas wells, which increases to 37% in 2015 and 41% in 2016. In exchange Legacy paid $355 million cash and 10% of its newly created IDRs (valued at $2.5 billion by this deal). WPX Energy owns substantial low decline gas assets in New Mexico's San Juan basin and the megaprolific Marcellus shale where production is expected to increase 28 fold between 2007 and 2035. The deal allows for WPX Energy to acquire an additional 20% of Legacy Reserves' IDRs in exchange for some of these assets.
Legacy Reserves now has a liquidity source 19% larger than every previous acquisition combined. Given management's successful track record of integrating those acquisitions, long-term income investors can be confident that Legacy Reserves' distribution is not only safe but likely to continue strong and consistent growth for years to come.
Foolish takeaway
Legacy Reserves and Mid-Con Energy Partners may be small and little known but represent two excellent ways for long-term income investors to cash in on America's energy renaissance. With generous and moderately growing yields secured by the highest distribution coverage ratios in their industry, unit holders of these MLPs can rest easy and look forward to at least a decade's worth of market outperformance.
