Not many investments have been as hot in 2010 as our favorite master limited partnerships (MLP). The unweighted average return for our 20 Conservative, Growth and Aggressive Holdings exceeds 20 percent this year. That bests the S&P 500 by more than 20-to-1 and tops the broad-based Alerian MLP Index as well.

The problem now is price. A couple months ago in the wake of the May Flash Crash, all of our picks were selling well below our target buy prices. Now, after a powerful rally, most are selling well above those targets.

In a normal year, cash distributions contribute the lion’s share of MLP returns. Moreover, unit prices follow distribution growth over the long haul. Prices can trade well above or below trend for a considerable time. But sooner or later, they’ll return to it.

During MLPs’ spring-summer swoon, we cautioned against the use of stop-losses in this sector, and particularly trailing ones. And all too often, investors were whipsawed out of good positions on jagged volatility that later proved to be meaningless as prices went on to new heights, leaving stop users out and on the sidelines at abysmal prices.

We’re still adamant that stops will raise rather than lower your risk in MLPs, which should be primarily held for long-term income and wealth-building. But a new danger has again raised its ugly head: the risk of overpaying for good companies, thereby ultimately ensuring mediocre returns.

You’ll never do that as long as you resolve not to pay more than our buy targets, which are set to mirror the growth of underlying business. Volatility comes with the territory, particularly in this market. But as long as the MLP’s business stays on track–as all of ours did in the second quarter of 2010–its price will eventually exceed our target. Meanwhile, it will continue to pay tax-advantaged cash distributions that are both safer and superior to almost anything else out there.

A number of readers, however, have asked us if they shouldn’t just wait for the next market event to produce prices well below our targets, as the Flash Crash did this spring. Most have cited popular macro worries such as a potential double-dip recession as practically assuring another steep correction. The implication is that purchases now would be foolhardy, even if made below our buy targets.

We certainly won’t deny that this is a fear-charged market where huge moves are possible, even if nothing significant happens. And we wouldn’t be the least bit surprised if there were a correction in our favored MLPs by the end of the year, should they get caught up in a general maelstrom.

The problem is such events are inherently impossible to truly predict. You may wind up waiting a very long time for a correction that will only occur from much higher prices. Although many MLPs have taken out their pre-2008 crash highs, it’s hard to really call them overvalued. That’s because underlying businesses and distributions have also grown markedly over that time, earning them higher unit prices.

Consequently, we continue to advocate a strategy of gradual accumulation of MLPs in your portfolio. Your focus should depend on how much risk you’re willing to take. Those who can’t afford to take risks should still focus on picking up the Conservative Holdings below our buy targets, while those that can handle the volatility that comes with betting on energy prices need to look at Growth and Aggressive selections.

There’s an alternative, however, for those who want to take a more aggressive approach on entry prices: Set buy orders at what you would consider dream prices for the MLPs you want to ultimately own. If we do see that correction, you’ll wind up owning them at prices that ensure powerful long-term returns–just as those who followed our admonition to buy this spring have. And if there’s no correction, the worst you’ll have is an unfilled order.

Most brokerages will let you set orders wherever you want. If you’re entertaining the hope they can be realistically filled, however, you’ll have to depart at least a little from pure fantasy. Enterprise Products Partners LP (NYSE: EPD), for example, did trade under $20 at the market lows of late 2008 and 2009. A return to that level, however, is far less likely than a potential revisiting of its spring 2010 lows of under $30.

In fact, the spring lows–or close to them–are the logical places to put buy orders for most of our recommendations. In the Conservative Holdings, that’s the $16 to $17 range for Genesis Energy LP (NYSE: GEL), the high 50s for Kinder Morgan Energy Partners LP (NYSE: KMP), the low 40s for Magellan Midstream Partners LP (NYSE: MMP), $60 or so for Sunoco Logistics Partners LP (NYSE: SXL) and the high 20s for Spectra Energy Partners LP (NYSE: SEP).

Turning to the Growth Holdings–which combine fee-based assets with more commodity-price sensitive operations–DCP Midstream Partners LP (NYSE: DPM) hit a low of less than $28 this spring. For Energy Transfer Partners LP (NYSE: ETP), the low was around $40. Inergy LP (NSDQ: NRGY) saw a low of $30.35 on the day of the Flash Crash. Kayne Anderson Energy Total Return Fund (NYSE: KYE) touched $20.07. Targa Resources Partners LP (NSDQ: NGLS) saw $20.45 and Teekay LNG Partners LP (NYSE: TGP) actually filled an order at $19.75 that day.

Finally, the highly commodity-price sensitive Aggressive Holdings had the greatest volatility in the spring. Encore Energy Partners LP (NYSE: ENP) went below $10 at one point. EV Energy Partners LP (NSDQ: EVEP) fell from the mid-30s in late April to barely $21 in early May. Legacy Reserves LP (NSDQ: LGCY) moved under $18 a one point.

Linn Energy LLC (NSDQ: LINE) went from nearly $30 to a low of $12.60 in just two days of trading. Navios Maritime Partners LP (NYSE: NMM) went from about $20 to a low of $12.17 in little more than a week in early May. Penn Virginia GP Holdings LP (NYSE: PVG) fell as far as $15 and Regency Energy Partners LP (NSDQ: RGNC) broke below $20 briefly for two trading sessions.

Again, we’re not predicting a return to these prices. In fact, our view is anyone who bases their whole strategy on holding out for another Flash Crash is going to be sitting in cash yielding less than half a percentage point, possibly forever. But again, this is one fear-charged market in which almost anything is possible. And as long as you’re not betting the farm, there’s nothing wrong with taking a flyer on a return to the ridiculous.

A Look at the Numbers

In the meantime, the rest of our MLP Profits Portfolio Holdings have now reported second-quarter numbers. I recap them below. Note that Teekay LNG Partners isn’t scheduled to report results until early September. Also, Kayne Anderson Energy Total Return is a closed-end mutual fund, not a company.

Starting with the Growth Holdings, DCP Midstream posted slightly higher distributable cash flow (up 7.3 percent) than a year ago, enabling management to lift the quarterly distribution by 1.7 percent. The company also set the stage for second half 2010 growth by completing the acquisition of wholesale propane assets in the Mid-Atlantic region, including an import terminal and an above ground storage facility at Chesapeake, Virginia.

DCP also entered a natural gas liquids infrastructure venture with EQT Corp (NYSE: EQT) to develop opportunities in the Marcellus Shale. And it reported progress on the expansion of its Michigan gas gathering system, which it expects to complete in early 2011.

Second-quarter distribution coverage was in line with forecasts at 1.0-to-1, as was six-month coverage of 1.14-to-1. That was despite lower cash flows due to turnaround time at gas gathering and processing assets in Texas and a planned shutdown of a propane terminal, which offset asset expansion and higher cash flow at the natural gas liquids logistics division.

Like all Growth Holdings, DCP’s earnings are combination of cash flows from fee-generating assets (55 percent 2010 margin)–which it continues to expand–and operations that are more commodity-price sensitive such as gathering. The company tried to hedge a portion of this exposure. Though much is simply activity that’s affected by price swings, it’s now hedged over 90 percent of overall margins.

The good news is expansion is centered on fees and infrastructure, which should protect cash flows and distributions though propane expansion has made both more weather sensitive. The latter makes the first and fourth quarters more important than the recently passed second and in-progress third quarter. The company is also set to benefit from what amount to asset dropdowns from its general partner, a joint venture between energy giants ConocoPhillips (NYSE: COP) and Spectra Energy (NYSE: SE).

That should add up to reliable cash flows and distribution growth going forward. Hedging policy is multi-year, extending into 2015. And after a public offering of equity units announced with the earnings, the balance sheet is sound, with no near-term refinancing risk.

DCP’s share price is still above our target of $33 despite backing off a few points since the earnings announcement. That looks a lot like “buy on rumor, sell on news.” And we certainly did like the news, which points to more distribution and unit price growth ahead. But we’d still be disciplined and wait for our target. DCP Midstream Partners LP is a buy only at 33 or below.

Energy Transfer Partners units also appear to have been bid up in anticipation of blockbuster returns and sold off when they were largely achieved. Headline earnings per share swung to a loss. But as every MLP Profits reader should now be aware, taxable profits are a meaningless number when it comes to master limited partnerships, which intentionally minimize them as the tax code allows.

Rather, the prime number is distributable cash flow (DCF), which surged 48.5 percent in the second quarter and vindicated management’s assertion that lackluster first-quarter results were not an indication of weakness. Second quarter coverage was a comfortable 1.24 times the distribution. And both midstream energy and propane distribution turned in solid showings, with cash flow rising 25 percent company-wide over last year’s levels.

Expansion has been the name of the game at Energy Transfer since its inception in the 1990s. And management continues to lay the groundwork for major growth in assets and cash flows with its massive infrastructure projects in shale areas. The Tiger pipeline’s original capacity of 2 billion cubic feet per day, for example, is on target for completion in the first quarter of 2011, with a further expansion of 400 million cubic feet a day on track for the latter half of 2011–all fully contracted.

The company also has a high growth venture in the Marcellus shale, aided by general partner Energy Transfer Equity’s (NYSE: ETE) stake in Regency Energy Partners. The LP contributed a substantial ownership interest in an operating project in an accretive deal earlier this year that retired 12.3 of its units. Overall growth capital spending for 2010 is coming in between $1.37 to $1.46 billion, versus $85 to $100 million on maintenance capital costs.

In its second-quarter conference call, management asserted it “sees positive momentum to return to distribution rate growth in the very near future.” That looks increasingly likely in light of these very positive returns and the news on the asset expansion front. The MLP does have commodity price exposure but has hedged 85 percent of it for 2011 and is locking in prices for inputs and outputs in 2012 as well.

The post-announcement selloff has taken Energy Transfer units down slightly below our buy target of 48. That’s a good level for those without a position to pick some up Energy Transfer Partners LP, though no one should pay more than 48.

Inergy has announced a merger with its general partner Inergy Holdings LP (NSDQ: NRGP). As was the case with the Magellan Midstream deal last year, the LP, Inergy LP, will subsume the general partner (GP), Inergy Holdings. For GP unitholders, the premium is only 10 percent of the 20-day average unit price prior to the deal. But they’re receiving a considerable step up in quarterly distributions amounting to about 30.8 percent, and that’s not including any future boosts by Inergy LP. The LP has now increased its payout 35 consecutive quarters dating back almost a decade.

As for LP unitholders, management sees the deal “neutral” to its cash distribution, meaning future increases are certain. It also projects “long-term accretion due to merger benefits,” in large part due to the elimination of the GP’s incentive distribution rights and cost cutting.

Inergy at the same time announced its profits for its fiscal 2010 third quarter. Cash flow rose 7 percent as recent acquisitions performed “as expected.” Retail propane gallon sales were up 7.4 percent from year earlier levels, while gross profit from other propane services besides distribution were up 9.1 percent. Gross profit from midstream operations was up 27.1 percent. Nine-month distribution coverage, meanwhile, was 1.21-to-1, enabling the LP to again raise its quarterly payout to 70.5 cents from the prior month’s 69.5 cents and 66.5 cents a year ago.

The GP-LP merger has, of course, ignited the usual flurry of legal challenges regarding whether GP holders are getting a fair shake in what is admittedly an “in the family” deal. The same challenges were turned back in the Magellan deal, though it’s possible Inergy LP may have to pay a bit more.

That possibility may be behind the steep slide in the LP’s unit price over the two days following the announcement. The units, however, still trade well above our buy target of 39, which is the highest we’d pay at this time for Inergy LP.

Aggressive Earnings

Turning to the remaining Aggressive Holdings reporting, EV Energy Partners reported a 12 percent boost in cash flow, excluding one-time items. DCF, meanwhile, surged 28 percent over last year’s level and 15 percent sequentially over first quarter tallies. Second-quarter coverage of the distribution was a solid 1.13-to-1.

The key was higher output, a 16 percent overall boost from a year ago and up 17 percent sequentially. That reflected in large part the successful acquisition of properties in the Appalachian Basin, closed Mar. 30, 2010, and in management’s words “now successfully integrated.” The company expects to close further deals for producing wells in the Anadarko, Arkoma and East Texas Basins with expected daily production of 14,850 to 16,850 thousand cubic feet (mcf) per day, roughly 85 percent of which is natural gas.

That will increase further the 69 percent of output currently coming from gas, increasing the vulnerability of cash flows to currently depressed gas prices. That exposure is offset by hedging, expense controls and–despite 14 consecutive quarterly increases–a conservative distribution payout policy. The MLP also enjoys the financial backing and asset drop down potential of the EnerVest group, a major financial advantage over rivals.

In its second-quarter conference call, management characterized its recent gas-heavy purchases as “buying reserves in the ground at $1.66 per mcf equivalent,” as well as “$8,000 per flowing mcf equivalent” or 5.9 times annualized cash flow. Those are indeed disciplined purchases that would be profitable even if gas prices tumble further from the current levels near multi-year lows.

Expansion is also being accomplished without taking on substantial debt. The MLP also announced this week a public offering that will raise further cash at close to EV’s lowest cost of capital ever. The MLP has net debt of only about $300 million, no near term maturities and substantial untapped credit lines, all ideal for more acquisition-led growth.

If natural gas prices should recover even to as much as $5 per mcf, it would have a very positive impact on producers like EV and would likely catapult its unit price to a new range. At this point, however, we prefer to value EV Energy Partners LP as though energy prices will remain on the low side, and we’re maintaining our buy target of 34.

Regency Energy Partners is also taking advantage of the bullish climate for offering new MLP units, announcing the issue of another 14 million this week mostly to pay down debt. Much of that was incurred when the MLP also announced the purchase of Zephyr Gas Services, a Texas-based field services company for $185 million. That deal will boost Regency’s midstream energy business by further boosting its ability to leverage existing gathering, processing and compression segments of the business.

The MLP saw its second-quarter cash flow rise 40 percent over year-earlier levels, largely on the strength of prior acquisitions of assets and operations in shale-rich areas of the US. The biggest deal so far was the purchase of 49.9 percent of the Mid-Continent Express Pipeline serving the Haynesville shale area. Regency also continues to add gathering capacity in the Haynesville and Eagle Ford shale areas.

Total gathering throughput rose 4.8 percent while processed natural gas liquids (NGL) volumes surged 27.3 percent. And pipeline volumes took off to the tune of 55.2 percent at the Haynesville joint venture, while they nearly tripled at the Mid-Continent Express Pipeline.

Management is gearing up for more gains, boosting “organic” capital spending on growth (excluding acquisitions) dramatically to $245 million from an original target of $180 million. That’s a clear sign of an improving environment as well as an aggressive management that continues to spot opportunities for further growth.

Distribution coverage came in at a solid 1.11-to-1 during the quarter. That’s not likely to be enough to support growth at least in the near term, particularly considering the aggressive capital spending plans and management’s desire to have “investment grade metrics.” Eventually, an improving environment combined with the profitable and growing asset base will se the table for a sizeable boost.

Until then, however, our buy target for Regency Energy Partners LP remains 24. Note that despite aggressive hedging, DCF is still heavily impacted by commodity prices. That should be a good thing as the global economy recovers and pushes energy prices higher with it. But it means volatility in the near term, and investors shouldn’t chase these units.