A 37.6 percent average gain is a strong performance in any year. In 2010 it was an extraordinary outperformance for the MLP Profits Portfolio, besting both the broad market and the Alerian MLP Index by wide margins. And it was on top of an even more robust 2009.

Pulling off a third consecutive big year will be challenging, mainly because today’s higher prices mean greater investor expectations with more potential for disappointment. We aim to make it by focusing relentlessly on business quality, while maintaining discipline and sticking to buy targets.

In early 2009 you could basically throw a dart at a list of master limited partnerships (MLP) and eventually score a big return. Even MLPs with fundamental weakness have been mostly off to the races.

This year begins with economic risks much lower than they’ve been in a while. Demand for oil and gas shale development infrastructure is still robust, with companies able to lock up prospective sales contracts before even raising needed capital.

Despite the recent rise in benchmark interest rates–notably the 10-year Treasury yield–our MLPs are still raising both debt and equity capital at historically low costs. That ensures cheap funding and high profits for new energy projects.

MLPs have also been able to eliminate refinancing risk by replacing once-ubiquitous credit lines with long-term, low-cost financing. Even if there were another credit crunch in Corporate America these companies would be able to pull in their horns until lenders were forced to come back to the market.

In short, operating conditions are bullish as ever for well-run MLPs. Our favorites are on track for another year of robust cash flow and distribution growth. On Jan. 12, for example, Genesis Energy LP (NYSE: GEL) announced a 3.2 percent boost in its quarterly distribution to 40 cents per unit, the 22nd consecutive quarter in which the LP has increased its payout. And because unit prices follow distributions over time, that’s a powerful catalyst for another year of solid capital gains as well.

Offsetting this bullishness, however, are much higher valuations. This means, despite the growth in payouts, lower dividend yields across the board. Even the riskiest energy MLPs, for example, now yield less than 10 percent. Second, it signals loftier investor expectations that are much more easily disappointed.

How our picks fare in the coming year will therefore depend on how well their business improvements match up to the increasingly lofty expectations behind their recent price gains. And from all indications, that promises to be a tall order indeed.

Genesis Energy’s unit price, for example, barely budged after the MLP’s dividend boost, which lifted the payout 11.1 percent above year-earlier levels. That rate of growth was an acceleration over the 9.9 percent year-over-year third quarter 2010 growth rate, which itself was faster than the 8.7 percent year-over-year second quarter rate.

Greater expectations are the biggest reason we’re insisting on maintaining buy targets on recommendations that in some cases are below current prices. And as we saw time and again last year, it doesn’t take much to trigger selling and create better entry prices.

A sizeable contingent of investors, for example, is still treating MLP equity issuances as poison. That’s despite the fact that money is invariably being raised at record-high unit prices, and therefore the lowest cost ever, as well as the fact that it’s being invested in accretive assets and businesses.

Investors who buy in the immediate aftermath of an equity issuance not only get a better price. But as the investment it’s financing is invariably boosting cash flow and distributions–to say nothing of business scale and efficiency–they get a more valuable MLP as well.

Given how low the cost of equity capital is for many MLPs–and the multitude of potential projects to invest in–we expect to see many new equity issuances in the coming year. We therefore anticipate many more opportunities to buy the dips in our favorites.

Dead Ahead: Earnings Season

We’re now moving full bore into reporting season for MLPs’ fourth-quarter and full-year earnings. Unlike other quarters’ reporting, this one is somewhat more complicated, involving filing the more complex Form 10-K as well as taxation documents.

As usual, Kinder Morgan Energy Partners LP (NYSE: KMP) is going all out to get its numbers to the public quickly, with an earnings announcement date of Jan. 19. But even some of the biggest MLPs, such as Enterprise Products Partners LP (NYSE: EPD), need a little more time. And some smaller fare won’t post numbers until early March.

The result is the impact of this earnings season on investor expectations and MLP unit prices will play out over five to six weeks rather than the usual two to three.

Following are the scheduled or estimated–indicated by “(e)”–reporting dates for our Portfolio Holdings.

Conservative Holdings

• Enterprise Products Partners LP (NYSE: EPD)–Jan. 31
• Genesis Energy LP (NYSE: GEL)–Feb. 24 (e)
• Kinder Morgan Energy Partners LP (NYSE: KMP)–Jan. 19
• Magellan Midstream Partners LP (NYSE: MMP)–Feb. 2
• Spectra Energy Partners LP (NYSE: SEP)–Feb. 4 (e)
• Sunoco Logistics Partners LP (NYSE: SXL)–Jan. 26 (e)

Growth Holdings

• DCP Midstream Partners LP (NYSE: DPM)–Mar. 3 (e)
• Energy Transfer Partners LP (NYSE: ETP)–Feb. 18 (e)
• Inergy LP (NYSE: NRGY)–Feb. 2 (e)
• Kayne Anderson Energy Total Return (NYSE: KYE)–Fund
• Targa Resources Partners LP (NSDQ: NGLS)–Mar. 1 (e)
• Teekay LNG Partners LP (NYSE: TGP)–Mar. 4 (e)

Aggressive Holdings

• Encore Energy Partners LP (NYSE: ENP)–Feb. 22 (e)
• EV Energy Partners LP (NSDQ: EVEP)–Mar. 16 (e)
• Legacy Reserves LP (NSDQ: LGCY)–Mar. 3 (e)
• Linn Energy LLC (NSDQ: LINE)–Feb. 25 (e)
• Navios Maritime Partners LP (NYSE: NMM)–Jan. 27 (e)
• Penn Virginia GP Holdings LP (NYSE: PVG)–Feb. 10 (e)
• Regency Energy Partners LP (NSDQ: RGNC)–Mar. 1 (e)

We’ll be recap highlights of all of these reports in MLP Profits as they appear and, most importantly, provide some context and meaning for unitholders. Then we’ll look at what we see through the prism of our MLP Profits Safety Rating System criteria, which are as follows.

Dividend Coverage. Lower payout ratios are always better. Investors should take care to ignore any analysis of MLP profits and dividend safety that mentions earnings per share, as MLPs minimize these by law. Rather, the only appropriate metric is distributable cash flow (DCF), which factors in MLP tax advantages.

DCF is calculated by adding back tax avoidance items to earnings per share, which are mainly accounting expenses that involve no outlay of cash, such as depreciation. Maintenance capital expenditures, which are needed to run the business and maintain equipment, are also taken out.

A coverage ratio of 1.25-to-1 is equivalent to a payout ratio of 80 percent and generally indicates a well-covered and therefore safe distribution with upside potential. The more fee-based income an MLP has, the higher a payout ratio it can sustain. Conversely, the more commodity-price-sensitive an MLP’s operations are the lower its payout ratio (a higher coverage ratio) should be to be considered safe. MLPs that meet this criterion also receive one point under the Safety Ratings System.

Percentage Fee-Based Income. MLPs that rely on fee-for-service or for use of their assets have much steadier cash flows than MLPs that rely more on economic activity and commodity prices. We award one point to any MLP that draws cash flows primarily from a fee-based business, such as operating pipelines and energy storage systems.

Note we don’t include tanker revenue locked in by long-term contracts or oil and gas producer revenue locked in by price hedging as equivalent to true fee income. That likely understates dividend safety at companies like Navios Maritime Partners LP (NYSE: NMM), which has locked in its tanker revenue with a series of long-term contracts that eliminate exposure to near-term swings in tanker rates. It also understates the security of Linn Energy LLC (NYSE: LINE), which has locked in selling prices for all of its natural gas output for the next five years.

Most companies in these businesses don’t hold these advantages. As such hedging is at the discretion of management and constrained by market conditions. It’s a point of demarcation between true fee-based businesses and companies that have simply hedged out exposure.

Neither do we include activities such as gas gathering, where activity depends heavily on commodity prices, or any processing, where margins depend on commodity price spreads. Profits in these areas are inherently variable.

Debt. Our MLP recommendations have been able to use generation-low interest rates to slash interest costs, eliminate refinancing risk by extending debt maturities economically and fund asset acquisitions and construction. As a result, balance sheets are stronger than ever.

Nonetheless, less debt is safer, so we award each a point under our Safety Rating System if debt is 60 percent or less of total capital. That level isn’t really impressive at an ordinary corporation. But with MLPs’ tax advantages, it’s a very healthy amount indeed.

Dividend Growth. Nothing highlights a strong MLP like consistent dividend growth. We award any company a point for growing its distribution over the last 12 months.

In the table “Safety Ratings,” we show how our Portfolio recommendations stack up on these counts. Ratings for the rest of the MLPs we cover are highlighted in How They Rate.

No doubt, at least some of these ratings will change as we start to get into earnings season.

The most common reason for a ratings change will be the payout ratio, as most MLPs post improved distributable cash flows thanks to a more benign environment.

We’re also likely to see improved dividend growth numbers, both from accelerated increases like Genesis Energy’s and from growth returning at others completing massive capital projects, such as Energy Transfer Partners LP (NYSE: ETP).

Energy Transfer last month reported the completion of two major pipelines ahead of schedule and on budget, the Tiger Pipeline and the Fayetteville Express Pipeline. Both are fully contracted and will begin adding generous, fee-based income to cash flow starting in the first quarter, providing funds for the MLP’s first payout increase since mid-2008.

The growing likelihood of a boost has already begun pushing Energy Transfer Partners to new 52-week highs this month. We look for more in the weeks ahead and are raising our buy target on Energy Transfer Partners LP to 55.

If anything convinces us to push buy targets higher for recommendations in the coming months, it will be cash flow and dividend growth–the forces that always push unit prices higher over time. Until they do, however, the best idea is going to be to stick to the old targets, only buying when prices dip to or below them.

That being said, Elliott and I did make a few changes in buy targets and other advice this week. Here’s a summary. For more, see How They Rate and the Portfolio tables.

Alliance Resource Partners LP (NSDQ: ARLP)–Buy @ 55 to Hold. Our call to buy coal-producing MLPs has paid off. We’re still bullish on the coal story, but this one now has some big gains and is likely to pause.

Alliance Holdings GP LP (NSDQ: AHGP)–Buy @ 45. In contrast to its limited partnership unit, the general partner of Alliance is still a buy, both because it’s undervalued and because it’s a potential takeover target for the LP.

Atlas Pipeline Holdings LP (NYSE: AHO)–SELL to Hold. The Chevron (NYSE: CVX) takeover of the parent has alleviated the group’s financial crisis, but there are more attractive places to invest.

Atlas Pipeline Partners LP (NYSE: APL)–SELL to Hold. The Chevron (NYSE: CVX) takeover of the parent has alleviated the group’s financial crisis, but there are more attractive places to invest.

Buckeye Partners LP (NYSE: BPL)–Buy @ 65 to Buy @ 70. The LP has bought out its GP interest and the purchase of an interest in a Bahamas terminal has dramatically increased cash-generating and dividend paying potential.

Capital Products Partners LP (NSDQ: CPLP)–Hold to Buy @ 10. An improved operating environment, coupled with improved management performance, makes this one a suitable choice for aggressive investors.

DCP Midstream Partners LP (NYSE: DPM)–Buy @ 35 to Buy @ 40. The more fee-focused this MLP becomes, the higher the valuation it deserves. Dividend growth has also resumed after a two-year hiatus.

Encore Energy Partners LP (NYSE: ENP)–Buy @ 21 to Buy @ 23. The buyout of the general partner interest by Vanguard Natural Resources LLC (NYSE: VNR) from Denbury Resources (NYSE: DNR) means everything for this aggressive energy producer.

Energy Transfer Partners LP (NYSE: ETP)–Buy @ 52 to Buy @ 55. The completion of the Tiger and Fayetteville Express pipeline systems will add to first-quarter cash flows and have put the pieces in place for long-awaited dividend growth.

EV Energy Partners LP (NSDQ: EVEP)–Buy @ 36 to SELL. It’s time to take profits in this natural gas-weighted producer, which has recently run up to new all-time highs.

Genesis Energy LP (NYSE: GEL)–Buy @ 24 to Buy @ 27. As noted above, year-over-year dividend growth has accelerated to 11.1 percent. Even after the recent run-up, this very secure MLP yields nearly 6 percent.

Legacy Reserves LP (NSDQ: LGCY)–Buy @ 27 to Buy @ 32. This Aggressive Holding hasn’t yet boosted its distribution during this cycle. But it’s only a matter of time as production expands and energy prices rise.

Linn Energy LLC (NYSE: LINE)–Buy @ 38 to Buy @ 40. Dividends are growing as the MLP adds production and continues to lock in prices for output.

MarkWest Energy Partners LP (NYSE: MWE)–Buy @ 35 to Buy @ 45. The MLP has continued to add fee-based assets, largely in the Marcellus Shale area. That’s dramatically reduced risk to cash flow and earns it a higher valuation.

Penn Virginia GP Holdings LP (NYSE: PVG)–Buy @ 25 to Hold. We’ve done well with this one, as coal prices have strengthened and the takeover by limited partner Penn-Virginia Resource Partners LP (NYSE: PVR) nears. We’re now in a hold mode until the merger is completed, which should be late next month following the scheduled Feb. 16 unitholder vote.

Regency Energy Partners LP (NSDQ: RGNC)–Buy @ 27 to Buy @ 29. The MLP continues to orient toward more fee-based and therefore lower-risk services, earning it a higher valuation. We’re also moving it from the Aggressive Holdings to the Growth Holdings on that basis.

Spectra Energy Partners LP (NYSE: SEP)–Buy @ 32 to Buy @ 33. Steady dividend growth earns this pipeline owner higher valuations little by little.

Tortoise Energy Infrastructure Corp (NYSE: TYG)–Buy @ 32 to Buy @ 38. The fund trades at a 13 percent premium to net asset value, but the value of its holdings is rising.

Vanguard Natural Resources LLC (NYSE: VNR)–Buy @ 27 to Buy @ 30. Rising energy prices, continued dividend growth and the Encore Energy Partners LP (NYSE: ENP) acquisition add up to a higher deserved valuation.

Burning Questions

Here are some frequently asked questions from readers in the past several weeks. I hope you find them illuminating.

Note that my co-editor Elliott Gue and I are hosting a dinner at the Orlando MoneyShow on Thursday night, Feb. 10. If you’re interested in attending, call our 1-800-832-2330 and ask for Special Offer Special Offer Code O01595 (that’s the letter “O” followed by a zero). The all-inclusive price is $299 per person.

Question: Several months ago you wrote about master limited partnerships’ takeovers of their general partners. What’s the latest?

Answer:  MLPs have figured out that the IDRs (incentive distribution rights) given to general partners (GP) are a real turn-off for investors and therefore push up their cost of capital. That’s why so many large ones have bought out their GPs, and it’s why we’ll see more such deals.

Of course, trying to figure out which GPs will be bought out and when is largely a matter of guesswork. We did well buying Penn Virginia GP Holdings LP (NYSE: PVG) last year, shortly before it was snapped up by Penn-Virginia Resource Partners LP (NYSE: PVR). And other publicly traded GPs have also benefitted from the takeover of Penn Virginia, as well of the former Buckeye GP Holdings LP and Enterprise GP Holdings LP. But you literally need a seat on the board to know when these things are going to come off with any accuracy, and even then acting on the information would be illegal.

Having said that, we’re still fans of the three remaining publicly traded GPs: Alliance Holdings GP LP (NSDQ: AHGP), Energy Transfer Equity LP (NYSE: ETE) and NuStar GP Holdings LP (NYSE: NSH).

Each should ultimately command a premium takeout price as their respective LPs try to access the lowest-cost capital possible for growth.

Question: I read a promotion for MLP Profits that mentions a Greek company run by a business genius, but I can’t for the life of me figure out what company it is. Is this something new, and if so why haven’t you shared it with your paid subscribers?

Answer: Newsletter advertising is designed to get attention, and this promotion obviously has done better than most. Rest assured, however, that anything we put in a promotion for MLP Profits will be an MLP you’ve seen time and again already as a paid subscriber.

In this case the company described is Navios Maritime Partners LP (NYSE: NMM). It’s a superbly managed owner and operator of dry-bulk tankers that we managed to initially recommend at a much lower price. It’s still an attractive buy mainly because of management’s continued ability to expand its fleet economically, thereby generating more cash flow and higher distributions. The latest of these occurred in November, when Navios bought two “Capesize” vessels already under long-term contracts.

Dry-bulk carriers, like tankers, have been operating in a tough environment, as the global economic slowdown has combined with an increased supply of vessels to drive down carrying rates. Navios has navigated these troubles by focusing on high-quality vessels backed by profitable contracts, even while many of its rivals have run aground. That’s in large part thanks to the prowess of Chairman and CEO Angeliki Frangou, who factors prominently in the promotional piece you read. And it’s very good reason to expect continued prosperity for this company, a buy up to 20.

Question: How does the tax package worked out between President Obama and the Republican leadership in Congress affect MLPs?

Answer: It doesn’t directly impact MLPs.

MLPs continue to enjoy substantial support in the US Congress on both sides of the aisle. Those not involved in energy and reliant on carried interest for profits were targeted for taxation in the last Congress, which is why we’ve advised consistently to stick only with energy-related MLPs. But even action against these MLPs–which are clearly set up solely to dodge taxes–looks unlikely at this point.

We continue to advise avoiding all MLPs that aren’t related to energy or other commodities. But for now, everything in How They Rate enjoys the same tax privileges in 2011 and 2012 that they did in 2010. That is that any part of the dividend deemed “return of capital” isn’t taxed in the year paid. Rather, it’s subtracted from your cost basis. If and when you sell, you’ll be taxed at the capital gains rate, with the amount determined by the difference between selling price and cost basis. Those who will MLPs to their heirs will pay no tax, as there’s a one-time step up in cost basis from the prior level to then-current prices.

Question: How do you calculate yields on your recommendations? Often the dividends you state don’t jibe with those on the quote systems I use.

Answer: We base our yield analysis on the indicated rate. That is, the amount of the most recently declared quarterly dividend times four, divided by the share price. The result is the percentage yield on which we base our valuation of the MLP, which in turn determines our buy/hold/sell advice along with safety and growth potential.

As you point out, this doesn’t always match up with what’s reported by some of the major quote services. One reason may be that an MLP is a relatively new issue, without at least a year-long dividend history. That’s certainly the case with Chesapeake Midstream Partners LP (NSDQ: CHKM), which has paid only one distribution since it was spun off from Chesapeake Energy (NYSE: CHK) last year. That distribution was actually a pro-rata payout of 21.65 cents, rather than the 33.75 cents per share the MLP has declared as its actual rate.

The 33.75 cents per quarter rate adds up to a $1.35 per share annualized rate and a yield of roughly 5 percent at the MLP’s current price. Many quote services, however, are only showing 3.2 percent, which is an annualized rate based on the 21.65 cents per share pro-rata dividend paid November 12. That’s also what’s shown now in How They Rate, which is also based on a live quote feed.

One thing you can be sure of is these discrepancies will eventually sort themselves out. In the meantime, we’ll keep you apprised of what distributions really are when we write up any recommendations. You can also identify true dividends by going to MLP websites, which are accessible by clicking on their names in How They Rate.

Question: Why are you still so negative on Cheniere Energy Partners LP (NYSE: CQP)? It pays a great dividend and seems to keep going higher.

Answer: We’re actually more negative the higher Cheniere rises. That’s because it’s only going higher for two reasons, both of which add up to trouble for investors. One is chasing yield. The other is the penny stock-like hype concerning exporting North American natural gas as liquefied natural gas (LNG).

At current prices Cheneire yields only about 7 percent. That rate hasn’t changed since the initial public offering, nor will it. The reason is all of the MLP’s revenue comes from capacity contracts at LNG import facilities that currently are basically idled. These were built in the middle of the last decade, when natural gas seemed destined to trade in the $7-$8-$9 neighborhood to perpetuity as demand rose and supplies shrank.

In the post-hurricanes Katrina and Rita environment, LNG imports looked like the future. Then came the shale gas revolution and the economics of gas were turned on their ear. LNG imports are no longer economic.

The problem Cheniere has is that it’s not simple to convert LNG import facilities to LNG export facilities. In fact, it’s likely to require billions of dollars of new investment, with uncertain payoff. And neither Cheniere nor its nearly bankrupt general partner are in any position to pay the bills.

To be sure, the contracts on Cheniere’s LNG facilities’ capacity are with Super Oils, arguably the strongest companies in the world. And even the shortest duration of these contracts won’t expire until 2020. That’s solid backing for the current yield, unless there was another giant call on the MLP’s capital–such as for LNG export conversion.

Either way, we’re not excited. The MLP has thrown off a total return of better than 80 percent over the last 12 months. If you’ve shared in that, count yourself lucky and take your profit. The worst you’ll be doing is selling an investment now at an all-time high paying an average yield with no hope of growth.