Doing better than expected is the key to higher unit prices for master limited partnerships (MLP) this year, just as it is for every stock.

Over the long term we’re concerned with our MLPs’ dividend safety and dividend growth. The former is the key to whether or not we can count on the distributions that are the cornerstone of MLP values. The latter is the key to whether our income stream will rise, which, in turn, is the key to a higher unit price (capital gains).

Like all income-paying stocks, MLP unit prices over time follow the level of distributions. And an MLP that steadily increases its payout over time will generate capital gains, just as surely as it pays more out in distributions.

The best time to get a fair read of MLPs’ prospects for distribution growth and overall financial health is when they release earnings numbers. Believe it or not, we’re now in the midst of yet another reporting season. In fact, five of our favored MLPs have now reported their numbers, with the rest due out over the next couple weeks.

The good news thus far, as you’ll read below, is that the first-quarter numbers are telling us the same thing that last year’s did. That is, our favored MLPs are still on track for robust, reliable growth in cash flows and, by extension, distributions.

The opportunities for expansion in fast-growing segments of the energy industry abound more than ever, as activity ramps up in everything from shale energy to natural gas liquids. Some of these opportunities are in production. Others are in infrastructure such as pipelines, processing centers, terminals and even refineries. But everywhere, we see more money being spent, more projects entered into and ultimately more cash flow for our MLPs.

At the same time, our MLPs’ cost of capital remains either at or near an all-time low, depending on how you measure. On the equity side, prices of many MLPs are hitting new highs. Every new equity offering can therefore be pulled off at a higher level, cutting the cost.

Meanwhile, the yield on the US Treasury 10-year note–commonly thought of as a benchmark interest rate for corporate borrowers–is well off its low of less than 2.5 percent reached late last year. But MLPs’ borrowing rates overall remain at rock-bottom levels, as interest rate spreads have dramatically contracted.

The low cost of capital combined with abundant opportunities to invest is a formula that continues to power our MLPs’ cash flows and distribution growth. And the best news about the numbers we’ve seen so far is there appears to be no end in sight for this extremely favorable trend.

There is a fly in this rather exquisite ointment, however: These are exactly the kind of results investors are coming to expect for MLPs.

It’s absolutely remarkable that the five MLPs highlighted below have all rallied in the wake of reporting their first-quarter numbers. They actually exceeded the raised expectations that have been built up in an almost uninterrupted bull market for MLPs and have been rewarded with higher unit prices still.

Moreover, there’s nothing to indicate the remaining companies to report won’t do the same, whether they’re mostly fee-based or focused mainly on commodity-sensitive operations. And that’s what we fully expect to report to you in the next couple of weeks.

On the other hand, everything we’ve talked about regarding the risks of rising prices definitely applies even more now. Higher prices force us to make a decision: Do the business results we’ve seen justify paying these prices. Can we possibly raise the buy target for an MLP that’s moved to a new all-time high? Or, despite the strong results on ground, is this a time to actually take some profits, or even cash out?

These are questions we as your editors are going to be wrestling with increasingly over the next several months. Admittedly, it’s a happy problem to have–deciding what to do with such gains that have mostly exceeded our expectations by a wide margin when we entered these positions. And many of you will have a different solution, due to particular tax consequences for example.

We’re not making any major changes to the Portfolio this issue. We’re not even changing any buy targets at this time, though we may in the coming weeks. We do, however, advise the following.

• Scrutinize your MLPs carefully as results are released. Make sure dividend coverage is strong, that operations are running well and that growth strategies are in place. These are mostly summarized in our MLP Safety Ratings, which we’ll have a complete listing of when earnings season ends.
• Cut and run from anything that isn’t measuring up, or which has a particular vulnerability on taxes. None of the MLP Profits picks to report so far has shown itself anything but an exceptionally strong company. But if you hold MLPs outside the Portfolios that are rated sells, it’s time to move on. Investors tend to buy everything in a sector that’s rising and even the weakest fare can become momentum plays, which can crash and burn at a moment’s notice. Don’t crash with them. Note also that the carried interest legislation that would largely eliminate tax advantages from any non-energy or commodity related MLP hasn’t gone away. That’s a good reason to sell any MLP that isn’t energy-related.
• Don’t use stop-losses to protect profits. As we saw with the Enterprise Products Partners LP (NYSE: EPD) incident on Mar. 15, even the strongest MLPs can trade sharply down intra-day on virtually no news. That’s because so many investors have set stop-losses in the mistaken idea that they can lock in a selling price. Instead what happens is a relatively minor move in an MLP can dump a huge volume of sell orders on the market at the same time, which overwhelm the bids and send the price crashing. Stop-holders will get out but probably the worst price of the day, only to watch the price bounce back as bids come on. Do adhere to our buy targets. We’ve generally set these to a 10 percent targeted return, that is yield plus cash flow/distribution growth. If an MLP goes above target, it’s not promising an adequate return to those who buy it now, no matter how strong its results are. Simply, you need to wait for a better price and buy something else in the meantime.
• Do set buy limit orders for MLPs you want to own. You may never get executed on a buy limit order set 20 percent below the current price. But if you are, you’ll be buying in at a bear market price, locking in a high and growing yield on a super MLP. That’s the surest road to riches in any market, no matter how uncertain and how high expectations overall are moving. Note the higher the risk of an MLP–commodity price risk is key here–the higher the yield should be before you buy. That’s how you’re compensated for risk, though many investors have forgotten that simple fact in their stampede to buy MLPs.

The Numbers

Here are the numbers for the five MLP Profits picks to report their first quarter numbers as of today.

Kinder Morgan Energy Partners LP (NYSE: KMP) raised its quarterly distribution to $1.14 per unit, 6.5 percent over last year’s tally and the fifth consecutive quarterly increase. Distributable cash flow–the primary measure of MLP profits–rose 8 percent, and CEO Richard Kinder projected full-year totals would beat management’s prior target for 2011.

The coverage ratio was a solid 1.06-to-1, well in line with management’s strategy of paying out essentially all cash flow after maintaining capital expenditures. During management’s first-quarter conference call Kinder also stated the company “is on pace to generate excess cash flow of almost $100 million for 2011, versus our annual budget of $37 million.”

Breaking down the big numbers, the company enjoyed rising transportation and storage volumes across all of its operations, from diesel fuel (11.3 percent) to natural gas liquids (12.4 percent). The natural gas pipeline segment benefitted from the completion of two new pipelines, Fayetteville Express and the Mid-Continent Express. Results were also strong at the Texas intrastate pipeline system and the recently entered KinderHawk joint venture in the Haynesville Shale.

Those new additions overcame a near-term shortfall at the Kinder Morgan Interstate Gas Transmission unit and the Rockies Express pipeline, due to a contractual agreement involving fuel cost recovery. Even the CO₂ transportation unit showed signs of snapping out of the doldrums, thanks to revived oil drilling activity in Texas’ Permian Basin. Kinder Morgan Canada enjoyed higher deliveries into Washington State.

In sum, the formula for Kinder’s steady wealth building remains the same as it’s been since the 1990s, when Richard Kinder and his team took the helm. That’s continued capital investment in a range of energy-based infrastructure, locking down capacity with credit strong customers and reaping a rising stream of fee-based cash flow from which to fund dividend growth. The company is now large enough to secure virtually any partner it wants and its cost of capital remains the lowest in its history.

That’s a powerful formula for long-term dividend growth and steady capital appreciation for unitholders, in addition to the handsome returns we’ve already realized. Buy Kinder Morgan Energy Partners up to 75 if you haven’t already.

Linn Energy LLC (NSDQ: LINE) didn’t increase its distribution with its first-quarter earnings announcement. The numbers themselves, however, continue to point in that direction later this year. Distribution coverage came in solidly at 1.15-to-1, as the company continued to complete acquisitions to boost reserves and output, particularly on the liquids side.

Management has completed $637 million in deals to date in 2011, including $238 million worth in the Permian Basin, which is increasingly a focus. Linn’s ability to raise low-cost capital greatly facilitates its efforts, including a successful $649 million public offering of equity that allowed it to retire 81 percent of two high cost debt issues due in 2017 and 2018.

Management guidance is now for 1.40-to-1 distribution coverage by profit for all of 2011. That, in CEO Mark Ellis’ words, “should provide us with the ability to increase our distribution this year.” The company has also taken its first step into the Williston Basin Bakken play, providing mighty upside to future upside from this oil play. Altogether, this year’s purchases add 4,000 barrels of oil equivalent per day of new output (91 percent liquids) and proved reserves of 29 million barrels of oil equivalent with a reserve life of 18 years based on current output rates.

The ability to make these acquisitions also demonstrates the conservative structure of Linn’s development, which basically locks in new production as well as selling prices well in advance. That policy has kept the producer’s natural gas output immensely profitable, even as most of its industry is just scraping buy. And it’s provided a ready source of internally-generated cash from which to pay distributions and further expand.

First-quarter output rose to 312 million cubic feet per day of natural gas equivalent, a 46.5 percent jump from year-earlier levels. The average selling price of $86.24 per barrel of oil equivalent is well below current spot market prices. Operating expenses per unit of production were flat year-over-year, while transportation expenses fell 12.5 percent per unit produced. Both are remarkable achievements for any company expanding this rapidly, particularly in liquids, where prices are much higher than for gas.

Those are perhaps the most hopeful metrics as well look at Linn’s prospective stock market performance after the explosive gains of recent years. Approximately 95 percent of expected total production from 2011 through 2013 is price-hedged, as is 80 percent for 2014 and 55 percent for 2015. That gives profits (and profit growth) considerably more assurance than for the average producer, of which Linn is anything but.

The price of Linn Energy units has pushed above our target of 40 in the wake of this good news. We’ll keep it there for now, with an eye toward increasing it later in the year.

Navios Maritime Partners LP (NYSE: NMM) turned in a 45.6 percent boost in first-quarter revenue, along with 56.8 percent and 52.1 percent gains in operating surplus and cash flow, respectively. The key was successful additions and integrations of new vessels, along with the signing of long-term charter agreements for all 16 of its vessels for an average remaining term of 4.3 years. With 95.2 percent of capacity is also locked down for 2012, management is now turning its attention to adding new vessels with the proceeds of the recent equity offering.

Unlike other dry-bulk shipping companies, Navios Maritime has been able to consistently charter its first-rate fleet at good rates. The average contractual charter out rate, for example, will actually rise in 2011, 2012 and 2013. Moreover, contracts are insured from credit default by an AA+ rated European Union governmental agency. That came in handy when Korea Line Corporation filed for receivership back in January, a non-event for Navios, as the contract was later affirmed.

Fleet utilization averaged 96.94 percent for the quarter, lower than last year’s 99.51 percent. That’s in part due to the sidelining of the Navios Apollon for an engine problem. But that was more than offset by a 30.1 percent jump in available days and a 26.9 percent jump in operating days, as the number of vessels run by the company increased to 16 from 13. The average age of the Navios fleet is just 5.2 years versus an industry average of 14.2 years, a major competitive advantage.

Distributable cash flow coverage of the distribution based on total units is 1.11-to-1, 1.33-to-1 for common units alone. Management has boosted distributions seven out of the 13 quarters Navios has been in business. These results coupled with likely future acquisition activity make another boost likely later this year. And with the company firmly focused on the burgeoning dry-bulk trade between resource producers and hungry Asian markets, robust growth looks set to continue for years to come.

We’ve already realized a hefty gain in Navios, which unlike MLPs sends out a 1099 at tax time rather than a K-1. But we’re looking for a lot more, in addition to the yield of 8 percent plus. Buy Navios Maritime Partners up to 22.

Penn Virginia Resources Partners LP (NYSE: PVR) has lifted its distribution for the first time since the November 2008 payment. The boost to 48 cents per unit (up 2.1 percent) reflects a 32.7 percent jump in cash flow and a 0.8 percent increase in distributable cash flow after one-time items.

That’s in large part the result of a robust coal mining market, which has stepped up mining on the MLP’s lands as well as royalties. Output hit 9.9 million tons in the first quarter, up from 8.2 million a year earlier. Meanwhile, royalties per ton hit $3.92, a 15.2 percent jump from last year’s $3.42. Operating income from coal and natural resource management surged 35 percent on a 35 percent jump in overall revenue.

Penn Virginia’s reliance on royalties rather than actual coal production is a major advantage in an industry where health and environmental lawsuits run rampant. But what really sets it apart as a master limited partnership from other producers is the natural gas midstream segment, which is basically a toll collector in prime areas of the Marcellus Shale and other key gas producing regions.

Division revenue in recent years has been subject to ups and downs in the gas market. But throughput is definitely in a uptrend, hitting 420 million cubic feet per day in the first quarter versus 308 million the prior year. That pushed up gross margin to one of its healthiest levels yet at $36 million, up 25 percent from the previous year.

Penn Virginia continues to push out this phase of the operation, spending $21.7 million on internal (non-acquisition) related growth projects including $12.9 million in the Marcellus Shale. That complemented $95.7 million in coal and natural resource acquisitions. Overall management expects to spend $150 million on internal growth in 2011, including $120 million in the Marcellus shale.

The foundation of effective capital spending is access to low-cost capital. The MLP’s unit price gains have helped immensely on the equity side. So has the now-completed consolidation of the general partner, which we once held in the MLP Profits Portfolio.

Penn Virginia now anticipates full-year distributable cash flow of $140 million to $150 million in 2011. First-quarter distributable cash flow coverage came in 1.21-to-1. Full-year projections based on the recently increased rate are 1.15-to-1 to 1.23-to-1. That should be enough for another payout boost, should management so desire. Penn Virginia Resource Partners remains a solid buy up to 28.

Sunoco Logistics Partners LP (NYSE: SXL) posted a 16.7 percent boost in its first-quarter distributable cash flow, as it generated cash flow from new fee-generating assets and saw strong utilization of existing assets. Distributable cash flow coverage of the payout was a very solid 1.2-to-1, which enabled management to boost the distribution another 1.3 percent to $1.195 per unit. That’s the 25th consecutive quarterly payout boost for Sunoco and an overall increase of 7.2 percent over the past 12 months.

As is the case for all Conservative Holdings, Sunoco’s cash flows are almost entirely from fee-generating assets, which produce level profit no almost matter what happens to energy prices. Growth is realized as the company adds new assets, locking in contracts with financially strong energy companies.

The chief focus is on pipelines and terminals, located in energy producing and refining regions. The first quarter saw high utilization in some regions, such as the West Texas Gulf, where crude oil takeaway capacity demand has been “exceptional,” quoting CEO Lynn L. Elsenhans. That was partly offset by the impact of unplanned refinery outages in the Northeast to which the company’s system connects. But the overall result was robust.

Operating income surged 29.3 percent during the quarter. Income from terminals (38.7 percent of profit) rose 31.8 percent, while the pipeline system (54.6 percent) produced an even better 46.4 percent gain. That more than offset the drop in refined products pipeline system income (6.7 percent) from $8 million to $5 million.

Expansion capital expenditures totaled $25 million in the first quarter, an 8.7 percent boost from last year’s outlay. That includes projects to expand natural gas liquids blending, mainly butane, as well as to expand the company’s refined products handling capacity in the western US. Management plans to invest a total of $100 million to $150 million in projects for all of 2011. These will be mostly for additions to existing infrastructure, by far the least risk way to expand assets and cash flow.

These are results that point the way to fatter cash flows and continued distribution increases for the rest of 2011 and beyond. The MLP’s unit price continues to levitate higher, hitting an all-time high this week. We’re keeping our buy target for Sunoco Logistics Partners at 85 for now.

Here are the remaining MLP Profits Portfolio Holdings and when they expect to report their calendar first-quarter 2011 results. We’ll update them in the coming weeks as they’re reported.

Conservative Holdings

• Enterprise Products Partners LP (NYSE: EPD)–May 10
• Genesis Energy Partners LP (NYSE: GEL)–May 10
• Magellan Midstream Partners LP (NYSE: MMP)–May 4
• Spectra Energy Partners LP (NYSE: SEP)–May 4

Growth Holdings

• DCP Midstream Partners LP (NYSE: DPM)–May 5
• Energy Transfer Partners (NYSE: ETP)–May 4
• Inergy LP (NYSE: NRGY)–May 10
• Kayne Anderson Energy Total Return Fund (NYSE: KYE)–N/A
• Targa Resources Partners LP (NYSE: NGLS)–May 5
• Teekay LNG Partners LP (NYSE: TGP)–May 13

Aggressive Holdings

• Encore Energy Partners LP (NYSE: ENP)–May 6
• Legacy Reserves LP (NSDQ: LGCY)–May 4
• Regency Energy Partners LP (NSDQ: RGNC)–May 5