At less than a dozen, upstream MLPs are far fewer in number than their midstream counterparts, and as a group they share a considerably shorter history. Yet, this often-unrecognized MLP segment continues to grow assets and refine strategies, providing opportunities for yield-hungry investors.

Here are some of the more interesting names, according to analysts covering the segment.

John Ragozzino, vice president with RBC Capital Markets, favors Memorial Production Partners LP for its record of astute acquisitions that portend continued above-average distribution growth, recently running at 8.3% per annum. Ethan Bellamy, senior research analyst at Robert W. Baird & Co., similarly likes Legacy Reserves LP for its history of solid acquisitions, helped by unparalleled access to deal flow in key areas. In addition, insiders hold an 18% stake in Legacy.

Both analysts have Outperform ratings on Mid-Con Energy Partners LP—the self-styled “waterflood guys”— whose portfolio of properties offers a less challenging decline curve outlook than the typical upstream MLP. And both see successive Permian property divestitures by Linn Energy as a strategy to reignite mo- mentum for the MLP as it improves its balance sheet and eventually shrugs off the cloud of an SEC inquiry.

For upstream MLPs, according to Ragozzino, visibility of production growth—and in turn, potential increases in distributions—tends to be less clear-cut than in the midstream sector, where it is easier to tie growth rates to a count of midstream projects, each generating a certain revenue stream.

“Each year is starting from scratch,” said Ragozzino. “The basic strategy is, first, to have an organic set of drilling opportunities to offset production declines and keep output relatively flat. That’s where the maintenance capital comes in. Anything fueling distribution growth is likely to come from acquisitions.” In 2013, the growth in distributions for the 10 upstream MLPs followed by RBC averaged 5.7%.

Ragozzino favors Memorial for the optionality it offers on natural gas, which is projected to account for 60% of production this year, as well as its management’s ability to communicate with the Street. But it is the management team’s acquisition track record, approaching $1.5 billion in acquisitions as a public entity, that is uppermost in Ragozzino’s recommendation.

“They’ve been incredibly aggressive and successful in executing a very robust acquisition and divestiture program,” said Ragozzino.

A novel feature—providing for a rising ownership interest to help offset declining production—was included in Memorial’s recently announced $173 million purchase of Eagle Ford oil and gas properties. Under the deal structure, Memorial bought the properties subject to a net profits interest (NPI) being retained by the seller that reduces annually and terminates after three years.

The result of the seller-retained NPI feature is that the working and net revenue interests held by Memorial in the properties escalate each year. For example, a working interest in 117 producing wells of initially 6.4% in 2014 rises to 9% and then 10.9% in 2015 and 2016, respectively, and caps out at 12.8% in 2017. With the rising working interest helping offset natural declines, the feature is projected to hold the effective annual decline rate of the proved producing properties to just 9%.

Ragozzino notes the deal structure minimizes the otherwise significant maintenance capex burden associated with an unconventional resource play and bolsters the estimated accretion of distributable cash flow. Assuming 60% long-term equity financing, accretion in terms of distributable cash flow per unit is estimated at 6.2%. With more than $500 million in liquidity on Memorial’s revolver, an imminent return to the equity markets is not anticipated, according to Ragozzino.

Given Memorial’s strategic relationship with Natural Gas Partners—its original parent, and now 100% owner of the MLP’s general partner, Memorial Resources Development (MRD)—a ready pipeline exists for further accretive acquisition opportunities. Some 700 billion cubic feet equivalent of assets are available to be dropped down from MRD, which through incentive distribution rights (IDRs) and its limited partnership holdings has every reason to work to raise distributions by the MLP.

Ragozzino’s price target for Memorial is $25 per unit, offering roughly 20% total return, based on yield of approximately 10% and about 10% capital appreciation. Annual distributable cash flow per unit is projected to rise to $2.28 and $2.38, respectively, for 2014 and 2015.

Market intelligence

Robert W. Baird’s Bellamy expects first-quarter results reported by the upstream MLPs to again be sprinkled with one-time events, as with the final quarter of 2013. “But upstream MLP businesses should be looked at over the medium and long term as far as their ability to continually provide that distribution to investors,” he emphasized.

In that vein, Bellamy favors Legacy Reserves, an MLP that is “definitely a family business,” led by CEO Cary Brown and his father, with insiders holding 18% of the limited partnership units. Consistency in strategy has been maintained as it transitioned to a public MLP format in 2006, and investors are aligned on a "pari passu" basis, on "equal footing," with management. No IDRs have been issued by the MLP.

“In terms of management, they shake out at the top of my list,” said Bellamy. “I’m very comfortable that they’re not going to pay top dollar at an auction for something that might not work out. They view it as definitely their own money.”

Bellamy also cites an advantage in terms of Legacy’s superior market intelligence of the Permian Basin.

“What we really like about these guys is that they are in Midland, they’ve done about $1.6 billion in acquisitions since going public, and they see all the transaction flow in Midland, including small deals, in part due to a Section 1031 [like-kind exchange – LKE] business. Their on-the-ground relationships and knowledge of the Permian are without peer.”

In the short term, the heated market conditions in the Permian may not work to Legacy’s advantage, prompting it to purchase properties elsewhere. Recent acquisitions include CO2 flood properties in Caprock Field in New Mexico, with an inclining production profile, and low-decline oil assets in Montana. Other purchases may include gas-levered acquisitions in the Midcontinent, according to the company.

“The nuance is that the Permian is so hot that it is going to be hard to be a buyer of proved developed producing [PDP] assets when almost everything has stacked pay under it,” commented Bellamy.

At the same time, Legacy may offer “wild-card” upside at some point from 27,500 acres that are prospective for horizontal Wolfcamp in key Midland Basin counties (Martin, Midland, Glasscock, Upton and Reagan). No plans are in place for near-term monetization, but any value brought forward by another partnership or asset swap would be additive to estimates and target price, Bellamy noted.

The analyst’s price target for Legacy is $29 per unit, offering over 23% total return, based on a yield of 9.5% and capital appreciation of 14%-plus. Annual distributable cash flow per unit is projected to be $2.41 in 2014 and $2.49 in 2014 and 2015, respectively.

Oil bulls

For investors with a bullish outlook on oil, Mid-Con Energy garners an Outperform rating from both Bellamy and Ragozzino. What makes Mid-Con stand out from its peers is its highly unusual production profile: whereas other upstream MLPs each year face the challenge of offsetting what are typically low-to-mid teens natural production declines, properties in Mid-Con’s waterflood portfolio initially have an inclining production profile before settling down to a generally fairly shallow decline rate.

Bellamy describes Mid-Con president and CFO Jeff Olmstead as “a very sharp, solid guy” and ranks the management team as among the leading world experts on waterfloods. Management owns roughly 8% of Mid-Con, while private-equity sponsor Yorktown Energy Partners owns approximately 12%. Yorktown committed capital to form Mid-Con Energy III, which acts as an “incubator” of waterflood projects.

“Yorktown takes the risk and puts most of the capex to work at the parent,” explained Bellamy. “And once they have the flood working, it gets sold to the MLP.”

The first such dropdown was announced in March, with the MLP acquiring five additional properties in Oklahoma and Texas for $41 mil- lion. Of the purchase price, $7 million was in cash, while the other $34 million came from the issuance of 1.5 million common units in the MLP. According to Ragozzino, the transaction was “nicely accretive at 4.8% and points to a sponsor which remains willing to take on additional equity as currency in A&D transactions.”

Dropdowns typically occur as invested capex reaches 75% to 80% of a waterflood’s total projected cost, leaving 20% to 25% of capex to be invested at the MLP level, typically for additional water injection wells and water supply facilities. The benefits that ensue—say, a further buildup in reservoir pressure, but as yet no near-term production gain—may not be immediately apparent. Nevertheless, the upfront costs will bear fruit in the longer term and underscore an advantage in maintenance costs.

“The capex will have a positive effect on the production profile in the longer term,” said Ragozzino. “You’ll have slightly more organic growth and probably offset more of the declines on a long-term basis. Overall, you’ve got a much more efficient asset base.”

The relative benefits of these upfront and other costs over time are measured in terms of an “asset-intensity” metric, calculated by the percentage of maintenance capital to distributable cash flow. For Mid-Con, asset intensity is estimated to be at an unusually attractive level of about 14%. This compares to an average of about 40%—and in some cases, considerably higher—for upstream MLPs as a whole.

So what’s not to like?

For Bellamy’s taste, Mid-Con would be better served if it were more hedged—and more methodical in its hedging—given its 98% liquids profile. Ragozzino also views limited hedging as a potential drawback. As of March, Mid-Con had 82.2% of its estimated oil production for 2014 hedged at an average floor price of $93.74 per barrel, but only 18.7% of its 2015 production hedged at $91.02 per barrel. A partial offset is Mid-Con’s lower-than-average debt levels, at less than two times EBITDA (earnings before interest, depreciation and amortization) and bearing interest rates of less than 3%.

In addition, both analysts say the “low-hanging fruit” in terms of additional waterflood projects in its current operating areas of Oklahoma and Texas have to a large extent been harvested. In particular, fewer opportunities are available to buy additional working interests in properties they already own—partly a reflection of Mid-Con’s prior success.

“They’ve done such a good job that other working interest owners don’t want to sell,” said Bellamy.

Bellamy and Ragozzino each have price targets of $27 per unit for Mid-Con, offering about 30% total return based on a yield of around 9% and capital appreciation north of 20%.

Permian sale strategy

Both analysts see Linn Energy LLC as a name laying groundwork for a further recovery in its stock price, following its well-publicized scrutiny by the SEC, with the stock potentially appreciating to the upper $30s. Sparking such a move would be its strategy to use the sale of its highly coveted Permian assets as a path to resuming growth.

Ragozzino acknowledges certain headwinds facing Linn: a high portfolio decline rate, an asset intensity that is fairly robust, and free cash flow that falls short of covering its current distribution without some reliance on its revolver.

“The bears will pound all day long that this company doesn’t even generate enough cash flow to fully support its distribution,” he said.

However, Linn has a Permian position that encompasses 55,000 net acres prospective for horizontal Wolfcamp development, as well as 17,000 barrels per day of associated production. Selling these assets will raise between $2 billion and almost $3 billion, he estimates, with proceeds being redeployed into more “MLP friendly” assets that on the one hand, have lower decline rates and are less capital intensive, and on the other, significantly bolster cash flow relative to Permian levels.

With the sale, “you’re closing the gap on both sides of the equation to the point that you should be able to sustain the distribution without any reliance on the revolver.”

Linn’s plan is to “compartmentalize” the A&D process into eight packages and, after identifying suitable assets to buy, use a tax-efficient LKE procedure to sell the appropriate assets and finalize the exchange. The process is expected to take place over a 12-to 18-month period, with successive package sales providing data on the accretive nature of the transactions.

“With four or five deals in the bag,” predicted Ragozzino, “the equity price will begin to show more life. And that gets them back into a position where they can do meaningful transactions on both the C corp and the asset side, because their equity is now a more valuable currency.”

Specifically, Ragozzino sees Linn regaining a “competitively advantaged” position as regards larger deal sizes—typically of $1 billion or more—that can “move the needle” for the company but are beyond the reach of other MLPs and smaller buyers.

Likewise, Bellamy is encouraged by the Permian sale plan, recalling Linn as having a “his- tory of selling assets that didn’t fit its mission.” From a tax perspective, the sale via a LKE process is attractive, but he cautioned it may end up as a “lower probability outcome” because it requires the alignment of two separate transactions. Meanwhile, he commended Linn for pursuing a conservative hedging policy; it is 100% hedged on gas through 2017, with oil hedged 100% this year and more than 50% in 2015 and 2016.

Ragozzino and Bellamy have price targets of $38 and $37, respectively, for Linn.