Income investors looking to profit from the United States' $890 billion energy boom need look no further than midstream master limited partnerships, or MLPs. These providers of transport and storage pipelines and processing facilities are vitally important to oil and gas companies and usually operate on long-term, inflation adjusted contracts. However, there are today 74 midstream MLPs to choose from; this article's goal is to help income investors choose some of the best options for long-term income growth and market-beating total returns.
The safest distribution is one that has just been raised
A great starting point for finding well-run MLPs is to start with those that have consistent track records of growing distributions.
| MLP | Forward Yield | 10-Year Distribution Growth Rate | 10-Year Projected Annual Distribution Growth | 12 Month Coverage Ratio | 10 Year Projected Annual Total Return |
| ONEOK Partners | 5.30% | 6.09% | 9.66% | 1.08 | 14.96% |
| Magellan Midstream Partners | 3% | 10.54% | 14.29% | 1.62 | 17.29% |
| S&P 500 | 1.89% | 9.20% |
Sources: S&P Capital IQ, Yahoo Finance, Moneychimp.com, MLPdata.com.
As seen in this table, Magellan Midstream Partners (NYSE: MMP) and ONEOK Partners (NYSE: OKS), not only have a solid track record of growing distributions over the last decade, but analysts expect their growth rates to accelerate in the years to come. What's more, those distributions are safe and their growth is sustainable based on strong distribution coverage ratios. However, just how realistic are these analyst projections?
Why invest in ONEOK Partners?
ONEOK Partners just raised its distribution by 2%, which represents a 5.6% year-over-year increase.
On July 24, ONEOK Partners announced plans to invest $365 million to $470 million into Oklahoma's SCOOP (South Central Oklahoma Oil Province) play. The project consists of a gas processing facility with a capacity of 200 million cubic feet per day, or MMcf/d, and will represent 29% growth in ONEOK Partners' Oklahoma gas processing capacity.
Oklahoma's SCOOP isn't the only place ONEOK is betting big.
Thanks to North Dakota regulators installing strict gas-flaring limits, Bakken shale oil producers will have to pay to store and transport the natural gas that is produced as a byproduct of oil production.
Source: ONEOK and ONEOK Partners investor presentation at Wells Fargo "Kick the Tires" Conference.
In fact, ONEOK is executing on a six-year, $6 billion-$6.4 billion investment program that runs through 2016. This impressive organic growth initiative doesn't include $4.5 billion-$5.8 billion in yet to be announced projects or potential acquisitions. Management expects this growth pipeline to result in 6%-8% distribution growth for ONEOK Partners.
Analysts expect distribution growth to accelerate after 2016; with continued growth of oil and gas production in the Bakken and Woodford shales, as well as Oklahoma's SCOOP and the Permian Basin, I believe those projections to be valid.
Why invest in Magellan Midstream Partners?
| MLP | Operating Margins | Net Margins | Return on Assets | Return on Equity |
| Magellan Midstream Partners | 40.20% | 34.20% | 14.90% | 43.60% |
| Industry Average | 9% | 3.70% | 2.40% | 8.30% |
Source: Morningstar.com.
The key to Magellan's success has been its management team, which has proven itself a master of efficient capital allocation. For example, back in 2009, at the height of the financial panic, Magellan bought out its general partner at a dirt-cheap eight times EBITDA (earnings before interest, taxes, depreciation, and amortization). This greatly reduced its cost of capital, making it more competitive, and eliminated its incentive distribution rights, which doubled the amount of distributable cash flow available to pay distributions.
In fact, Magellan Midstream Partners has a proven track record of only selecting low-risk, highly profitable investments and acquisitions. In the last 10 years it has closed $3.7 billion in acquisitions and organic growth projects, such as:
- After the Gulf of Mexico oil spill, Magellan in 2010 acquired $289 million in oil and pipeline assets from BP for just eight to nine times EBITDA.
- The Long Horn pipeline expansion from the Permian Basin to Houston: $430 million investment, 50,000 barrels per day increase in capacity, EBITDA multiple of three.
- The Double Eagle pipeline, a joint venture with Kinder Morgan that will transport 50,000 barrels per day of condensate from the Eagle Ford shale to Magellan Midstream's Corpus Christi condensate splitter.
- The BridgeTex pipeline, a joint venture with Occidental Petroleum: 300,000 BPD oil from the Permian Basin to Houston.
Magellan Midstream Partners just met its previous guidance by raising its distribution 20% year over year in 2014, with 15% expected growth in 2015.
Given its track record and $1.6 billion in current and potential backlog projects, Magellan Midstream Partners has the potential for strong distribution growth in the years to come.
Foolish takeaway
America's oil and gas boom is likely to last for decades, and long-term income investors can rest assured that ONEOK Partners and Magellan Midstream Partners are three excellent choices to profit from this megatrend. These companies' long track records of growth, through accretive acquisitions and organic expansion projects, combined with their impressive current backlogs, give me confidence that their distributions are set to grow for many years to come.
