The Zacks Oil and Gas - Refining & Marketing MLP industry appears on track for substantial gains as product demand and refining margins continue to move higher. The defensive nature of the stocks and their fee-based business models, together with built-in inflation protection, also bode well for investors. Building on this bullish narrative, operators like Targa Resources TRGP, Calumet Specialty Products Partners CLMT and Global Partners GLP have lots of upside and are likely to see impressive revenue and cash flow growth.
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 owned by these partnerships 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).
4 Trends Defining the Oil and Gas - Refining & Marketing MLP Industry???s Future
Sustainable Cash Flows: Considering the volatility in oil right now — especially the jitters associated with a looming economic slowdown (posing a risk to consumption) — a safer way of playing the sector would be to utilize MLPs, which offer considerable returns at a significantly lower risk. The assets that these partnerships own — oil and natural gas pipelines and storage facilities — typically bring in stable fee-based revenues under long-term contracts and have limited, if any, direct commodity-price exposure. In the longer term, these agreements result in steady cash flow through the boom-and-bust cycle. Even within fee-based contracts, a significant portion is of a take-or-pay type, meaning that the MLPs get paid irrespective of the volume of commodities that get transported.
Strong Margins: The industry’s improved fundamentals in the form of constrained supply and robust demand have led to rising refining profitability for the players involved. With product inventories running low and no near-term solution to replenish them, margins (especially for diesel and jet fuel) have set all-time highs. Overall, elevated consumption paired with considerably lower refining capacity in the OECD countries should provide a tailwind for refinery profits throughout the year. In particular, constrained Russian fuel exports in the wake of the Ukraine conflict have tightened refining fundamentals.
Ongoing Supply Chain Bottlenecks: 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.
Offsetting Inflation Impact Through Distribution Growth: 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 value destruction of the high inflationary environment prevailing currently.
Zacks Industry Rank Indicates Positive 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 #75, which places it in the top 30% 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 bright 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.
The industry’s position in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are optimistic about this group’s earnings growth potential. While the industry’s earnings estimates for 2022 have surged 58.7% in the past year, the same for 2023 have gone up 19.3% over the same timeframe.
Considering the encouraging 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 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 37.1% over this period compared with the broader sector’s increase of 29.4%. Meanwhile, the S&P 500 has lost 7.2%.
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 8.16X, lower than the S&P 500’s 12.66X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 3.85X.
Over the past five years, the industry has traded as high as 17.75X, as low as 5.79X, with a median of 10.41X, 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 Buy
Calumet Specialty Products Partners, L.P.: This downstream operator focuses on specialty products (oil, waxes, white oils etc.) and solutions, in addition to renewable diesel (or refining). CLMT targets high-performance markets for lubricants and engineered fuels, which provide ample growth opportunities for the partnership.
The 2022 Zacks Consensus Estimate for Indianapolis, IN-based Calumet indicates 76.2% year-over-year earnings per share growth. The firm beat the Zacks Consensus Estimate for earnings twice in the trailing four quarters, the average being 62%. Valued at around $1.2 billion, the Zacks Rank #2 (Buy) CLMT has surged 145.9% in a year.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Price and Consensus: CLMT
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 Houston, TX-based Targa Resources indicates 83.6% year-over-year earnings per share growth. TRGP beat the Zacks Consensus Estimate for earnings by 51.9% in the most recent quarter. The #2 Ranked stock has gained 49.4% in a year.
Price and Consensus: TRGP
Global Partners LP: GLP is a vertically integrated energy partnership focused on the distribution of gasoline, distillates, residual oil and renewable fuels, apart from owning several refined-petroleum-product terminals. Unlike most energy operators, which maintained their payout through the coronavirus-induced downturn, Global Partners is among the minority that continued to increase distributions.
The gasoline station and convenience store operator has an expected earnings growth rate of 163.4% for the current year. GLP pays out 60.50 cents quarterly distribution ($2.42 per unit annually), which gives it an 8.9% yield at the current unit price. Valued at around $920 million, the Zacks Rank #2 GLP has gained 23.7% in a year.
Price and Consensus: GLP
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Targa Resources, Inc. (TRGP) : Free Stock Analysis Report
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