These 3 Refining & Marketing MLP Stocks Are Worth a Closer Look
Elevated pump prices are raising worries of a demand destruction for the Zacks Oil and Gas - Refining & Marketing MLP industry as certain low-income consumers mull over tightening their belts to deal with the higher cost of daily commutes. Operators have also not been immune to supply-chain disruptions and cost inflation. But the defensive nature of the stocks and their fee-based business models, together with built-in inflation protection, have held up rather well. In this context, investors might want to focus on Targa Resources TRGP, Western Midstream Partners, LP WES and Sunoco LP SUN for attractive returns and cash flow growth.
Industry Overview
Master limited partnerships (or MLPs) differ from regular stocks since interests in them are referred to as units, and unitholders (not shareholders) are partners in the business. Importantly, these low-risk hybrid entities bring together the tax benefits of a limited partnership with the liquidity of publicly traded securities that earn a stable income. The assets that these partnerships own are typically oil and natural gas pipelines and storage/infrastructure facilities. The Zacks Oil and Gas - Refining & Marketing MLP industry is a sub-sector of this business model. These firms operate refined products' terminals, storage facilities and transportation services. They are involved in selling refined petroleum products (including heating oil, gasoline, residual oil, jet fuel, etc.) and a plethora of non-energy materials (like asphalt, road salt, clay and gypsum).
3 Trends Defining the Oil and Gas - Refining & Marketing MLP Industry???s Future
High Motor Fuel Price Impacting Consumer Demand: Operating results of the energy refining and marketing MLPs, which own oil and natural gas pipelines and storage facilities, are highly sensitive to prices for motor fuel. With prices at the pump skyrocketing after Russia’s invasion of Ukraine, consumption of gasoline seems to have weakened. Apart from fuel demand, any increase in petroleum costs also impacts convenience merchandise. Coupled with elevated inflation in the United States, the surge in gasoline prices is starting to influence consumer decisions that might lead to some kind of demand destruction. On top of that, higher petrol prices would spur even higher inflation, acting as a significant threat to usage.
Supply Chain and Labor Constraints: Despite the bullish energy landscape and improved demand environment, the industry has not been immune to supply chain disruptions and cost inflation. Macro issues like higher transportation expenses, driver scarcity and labor shortages have limited MLPs’ (or the energy infrastructure providers, also called the midstream group) ability to ship packaged volumes to their customers. Most operators have also felt the impact of inflation, which is rolling through the cost structure. What’s worse is that these headwinds across the system and the subsequent hit to profitability (due to difficulty in passing through the increased costs to clients) are expected to continue in the near future.
Distribution Growth Beneficial in Inflationary Environment: Investors are typically attracted to MLPs, thanks to reliable distributions and defensive characteristics. The major refining and marketing midstream players — being largely insulated to fluctuations in commodity prices — maintained their distribution levels through the crisis-stricken 2020. Now, with the energy space displaying secular demand growth, their relatively steady coverage should represent a more predictable midstream payout scenario in the near future, improving commodity price visibility. Meanwhile, as a response to the energy downturn, a number of these entities have been highly effective in managing cash outflows. Adjusting costs with the prevailing business activity, the partnerships have focused on the generation of free cash flow (post distribution payment) to lower debt and strengthen their financial position. The growing free cash flows could be used to boost investor returns through buybacks and distribution hikes. Finally, the distribution growth can also help investors to offset some of the impacts of high inflation.
Zacks Industry Rank Indicates Gloomy Outlook
The Zacks Oil and Gas – Refining & Marketing MLP is a 7-stock group within the broader Zacks Oil – Energy sector. The industry currently carries a Zacks Industry Rank #242, which places it in the bottom 4% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates challenging near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Despite the dim near-term prospects of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and its current valuation first.
Industry Outperforms Sector & S&P 500
The Zacks Oil and Gas – Refining & Marketing MLP industry has fared better than the broader Zacks Oil – Energy sector as well as the Zacks S&P 500 composite over the past year.
The industry has gained 73% over this period compared to the S&P 500’s rise of 13.5% and the broader sector’s increase of 45.6%.
One-Year Price Performance
Industry's Current Valuation
Since midstream-focused oil and gas partnerships use fixed-rate debt for most of their borrowings, it makes sense to value them based on the EV/EBITDA (enterprise value/ earnings before interest tax depreciation and amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of non-cash expenses.
On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, the industry is currently trading at 10.33X, lower than the S&P 500’s 14.98X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 5.46X.
Over the past five years, the industry has traded as high as 17.75X, as low as 5.79X, with a median of 11.11X, as the chart below shows.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
3 Oil and Gas - Refining & Marketing MLP Stocks to Focus On
Sunoco LP: This downstream operator focuses on motor fuel distribution to convenience stores, independent dealers and commercial customers. A participant in the transportation and supply phase of the U.S. petroleum market across 30 states, Sunoco enjoys stable demand for its services.
SUN pays out 82.55 cents quarterly distribution ($3.302 per unit annually), which gives it an 8% yield at the current unit price. Sunoco beat the Zacks Consensus Estimate for earnings twice in the trailing four quarters, the average being 44.4%. Valued at around $4.1 billion, the Zacks Rank #2 (Buy) SUN has gained some 37.7% in a year.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Price and Consensus: SUN
Targa Resources: A leading provider of integrated midstream services in North America, Targa Resources’ fractionation ownership position in Mont Belvieu is among the company’s best midstream assets. The facility has connectivity to supply, storage, terminalling infrastructure, as well as to end markets through petrochemical complex and exports. The company also has state-of-the-art LPG export facilities on the Gulf Coast at its Galena Park Marine Terminal, which is interconnected to Mont Belvieu.
The 2022 Zacks Consensus Estimate for this Houston, TX-based firm indicates 73% year-over-year earnings per share growth. Targa Resources beat the Zacks Consensus Estimate for earnings in two of the last four quarters. The Zacks Rank #3 (Hold) stock has a trailing four-quarter earnings surprise of roughly 61.1%, on average. TRGP shares have surged around 150.3% in a year.
Price and Consensus: TRGP
Western Midstream Partners: WES is engaged in gathering, processing, compressing, treating, and transporting natural gas, condensate, natural gas liquids, and crude oil. Western Midstream Partners’ top-class asset portfolio, financial strength and ability to generate stable cash flows should boost unitholder returns.
The 2022 Zacks Consensus Estimate for The Woodlands, TX-based firm indicates 19.3% year-over-year earnings per share growth. Western Midstream partners pays out 32.70 cents quarterly distribution ($1.308 per unit annually), which gives it a 5.2% yield at the current unit price. Valued at around $10.1 billion, the Zacks Rank #3 WES has gained some 39% in a year.
Price and Consensus: WES
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