Wunderlich Starts Coverage on Some of the Lower Risk High-Yielding MLPs

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Upstream master limited partnerships (MLPs) underperformed the market in the third quarter of this year. The good news for investors looking to get on board is that the road ahead looks encouraging. Exploration and production (E&P) MLPs underperformed in the third quarter also, falling in line with the wider MLP sector, as represented by the stocks in the Alerian MLP index, generating an average return of negative 2.2% and lagging other major indices.

In a new research report, the MLP analysts at Wunderlich initiate coverage on some of the top-yielding MLPs. As the year rolls over and we head into 2014, they feel more confident about upstream MLPs. Looking at last month’s encouraging performance, the signs appear very positive. In the month of September, the MLP sector fared much better, outperforming other yield-oriented asset classes. With the chances of a Federal Reserve tapering being pushed out as far as the spring of next year, and no meaningful increase in interest rates until 2015, the MLP asset class may be poised to draw the kind of attention and cash flows it has prior to the third-quarter downturn. Here are the top stocks to buy from Wunderlich.

Breitburn Energy Partners L.P. (NASDAQ: BBEP) is a top new name to buy at Wunderlich. Half of Breitburn’s production output is natural gas, though that is set to change. Management plans to focus future acquisitions on oil-intensive energy fields, and it expects that 60% of its output will come from oil in 2014. A key virtue: Breitburn is known for the industry’s most accretive acquisitions, which means that each deal generates above-average returns. Investors are paid an outstanding 10% distribution. It is important to note that MLP distributions can contain return of principal. The Wunderlich price target for the stock is $22, and the Thomson/First Call estimate is $21. The stocks closed Wednesday at $19.185.

EV Energy Partners L.P. (NASDAQ: EVEP) is only rated Neutral, but the analysts do like the potential and the stock could be upgraded. The company is an oil and gas upstream company formed in September 2006, with a geographically diverse asset base with properties in the Barnett Shale, the Appalachian Basin, Mid-Continent and the Permian Basin. Investors are paid an 8.17% distribution. The Wunderlich price target is $39, but the consensus is much higher at $48. EV closed Wednesday at $37.78.

Legacy Reserves L.P. (NASDAQ: LGCY) is an oil and gas upstream MLP headquartered in Midland, Texas, having properties in the liquids-rich Permian Basin, Mid-Continent and the Rocky Mountains. Legacy has a very strong hedging strategy in place to mitigate cash flow volatility. The company has 92% of its expected oil production and 67% of its natural gas production hedged through 2014 at favorable prices. Investors are paid a solid 8% distribution. The Wunderlich target for this top name is $31, while the consensus target is at $30. Legacy closed Wednesday at $28.92.

Memorial Production Partners L.P. (NASDAQ: MEMP) is a newer name to the game, having gone public via an IPO in 2011. With a strong acquisition track record, high reserve to production ratio, affiliation with a drop-down sponsor and a solid coverage ratio providing headroom to improve future distributions, the Wunderlich analysts believe the trading multiple should move in line with the sector, resulting in attractive returns from near-term potential upside. Investors receive a 9.8% distribution. The Wunderlich price objective for the stock is $24, and the consensus is posted at $23.50. Memorial closed Wednesday at $20.87.

QR Energy LP Inc. (NYSE: QRE) has a higher liquids proportion of 69%, versus a peer average of 51%. The company also supports its cash flow with a very aggressive hedging strategy covering about 80% of its production. The company also has a solid sponsor in the Quantum Resources Fund. The fund has a 32% stake and already has provided two asset drop-down opportunities in the past to fund acquisitions and has potential to provide more in the future. Investors are paid a huge 10.94% distribution. The price target for the stock is $20, and the consensus is at $19.50. QR closed Wednesday at $17.81.

Vanguard Natural Resources LLC (NASDAQ: VNR) is an upstream MLP that acquires mature oil and gas properties and pays unitholders much of the free cash flow. Vanguard also has adopted a contrarian strategy to acquisitions, opting for natural gas acreage, which has much less buying competition. Shareholders are paid 8.78% distribution. The Wunderlich target is placed at $31, and the consensus is at $32. The stock closed Wednesday at $28.23.

Wunderlich has focused on some of the more conservative high-yielding names. Other firms on Wall Street have sounded the alarm that some high-yielding MLPs may have to cut their dividends.

The average yield in the Alerian MLP index is only 5.7%. More conservative investors may want to consider companies like Enterprise Products Partners L.P. (NYSE: EPD), which yields 4.5%; Kinder Morgan Energy Partners L.P. (NYSE: KMP), yielding 6.6%; Plains All American Pipeline L.P. (NYSE: PAA), yielding 4.6%; and Energy Transfer Partners L.P. (NYSE: ETP), yielding 6.9%. They have far less trouble maintaining their payouts to investors. All four have consistently raised their distributions over the years and appear likely to continue.

With tapering and interest rate increases in the distance, investors have a good entry point to some of the top MLP names. A good portfolio tactic may be to mix a blend of the higher yielding names with the large cap mega names that dominate the Alerian index. This may supply the best of both worlds.

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