(07/31/13) Catalysts Energize Energy Transfer

Few investment categories offer the same attractive combination of present yield with growth potential as does well-positioned MLPs, says Igor Greenwald of MLP Profits.

Many pipeline operators have a huge growth opportunity in front of them. Advances in drilling techniques have unlocked the energy potential of new resource basins. And many of these are in desperate need of new pipes to process and transport the swelling streams of oil and gas they're producing.

The domestic bounty is rapidly transforming America into a low-cost producer and exporter of processed fuel.

The financial incentives now in place will assure rising export volumes for the foreseeable future and in turn require huge infrastructure investments, such as are needed, for example, to liquefy natural gas or to crack condensate into naphtha.

These are not trends that will reverse simply because the 10-year yield has rebounded to 2.5%. These are projects that will provide solid returns years into the future, for the partnerships that pick the right opportunities and execute well.

Like any investment, MLPs come with many hazards. The focus on yield can blind investors to excessive borrowing or other unsustainable business strategies that can maintain the appearance of profitable growth for a time.

Better to buy based on well-defined business opportunities and to know that if these are grasped, the distribution growth will follow. There are no low-risk 10% yields, but plenty reasonably secure 5% ones that could grow over time.

All of this is an argument in favor of the most financially stable MLPs with the brightest growth prospects, and thankfully, there are still some that are fairly valued. Many have weathered numerous booms and busts while vastly outperforming the stock market. They'll be around, and building the pipelines we badly need, long after interest rates have marched much higher.

Meanwhile, incentive distribution rights (IDRs) can boost the income stream of a general partner over time, to the corresponding detriment of limited partners. IDRs are especially lucrative after a long period of steady growth, which is exactly what's taken place among MLPs in the five years since the financial crisis hit.

One upshot was our new recommendation of Energy Transfer Equity (ETE) as a general partner poised to capitalize on lucrative IDR streams from several subsidiary partnerships.

ETE is the general partner of Energy Transfer Partners LP (ETP), the fourth-largest MLP by market value, and operator of natural gas gathering and transportation pipelines with a combined length of 47,000 miles.

ETE is also the general partner of another pipeline operator, Regency Energy Partners (RGP).

And ETP is itself a general partner of another MLP, Sunoco Logistics SXL. All of these MLPs owe incentive distribution rights, directly or indirectly, to ETE.

During its recent acquisition spree, ETE agreed to forego IDR payments from some of the businesses taken over by its affiliates, moves that will cost it $245 million next year, but less thereafter with the prospect of a big spur to growth, once these waivers expire in a couple of years.

Barclays recently estimated that after the waivers ETE's income stream could grow at a 15% annually compounded rate for five years, thanks to subsidiary IDRs.

So today's relatively modest 4.2% yield could be markedly higher in a few years without any change in the unit price.

ETE is a stable, financially secure MLP, with visible growth catalysts and the tailwind of affiliated IDRs. With units trading right around our initial price target, we're raising it to continue taking advantage of this opportunity. Buy ETE below $69.