The defensive nature of the Zacks Oil and Gas - Refining & Marketing MLP industry and its fee-based business model have held up relatively well amid the coronavirus-induced energy sector carnage.
With the commodity markets now showing signs of stability and volumes through pipelines slowly coming back, industry players like Sunoco LP (SUN), Suburban Propane Partners, L.P. (SPH), Global Partners LP (GLP) and CrossAmerica Partners LP (CAPL) are expected to benefit.
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 hybrid entities bring together the tax benefits of a limited partnership with the liquidity of publicly-traded securities. The assets that these partnerships own are typically oil and natural gas pipelines and storage 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 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
Uncertain Recovery of Volumes Moving Through Pipelines: While MLPs (or the energy infrastructure providers, also called the midstream group) have a lower correlation to oil and gas prices compared to their energy peers, this sector hasn’t been immune to the coronavirus-induced downturn. With exploration and production operators pulling back activities and curtailing production in response to sharply lower commodity pricing and demand, MLPs are facing volume contraction through their facilities, resulting in lower profits. Though some of the production shut-ins have returned in response to the gradually tightening fundamentals, most companies are in no hurry to boost output. They are primarily focusing on improving cost and increasing free cash flow rather than boosting production. This does not bode well for midstream volumes and re-contracting terms for pipeline operators.
Distributions Have Proven Resilient So Far: 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 — have managed to maintain their distribution levels thus far. Further, their relatively steady coverage and improving oil price visibility should represent a more predictable midstream payout scenario in the near future. Meanwhile, as a response to the energy downturn, a number of these entities have been highly effective in managing cash outflows. Adjusting costs with reduced business activity, the partnerships have focused on the generation of free cash flow (post distribution payment) to lower debt and strengthen financial position.
Fuel Demand Concerns Persist: Per the U.S. Energy Department's latest inventory release, distillate inventories are more than 7% above the year-ago-level, signaling plenty of oil product availability in the market. Therefore, fuel margins remain depressed. Further, with coronavirus still keeping majority of the customers away from air travel — as reflected in slackening forward bookings — consumption is yet to recover meaningfully. As a result, the already dire jet fuel (a derivative of distillates) market is unlikely to rebound anytime soon. This will not only affect refining profitability but also result in increased price volatility.
Zacks Industry Rank Indicates Gloomy Outlook
The Zacks Oil and Gas - Refining & Marketing MLP is a 12-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #187, which places it in the bottom 26% of around 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 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 surged 174.8% over this period compared to the S&P 500’s rise of 67.6% and broader sector’s increase of 107%.
One-Year Price Performance
Industry’s Current Valuation
Since midstream-focused oil and gas partnerships use fixed-rate debt for majority 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 noncash 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 17.65X. It is, however, significantly above the sector’s trailing-12-month EV/EBITDA of 6.16X.
Over the past five years, the industry has traded as high as 17.34X, as low as 6.66X, with a median of 12.84X, as the chart below shows.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
4 Oil and Gas - Refining & Marketing MLP Stocks to Keep an Eye On
Global Partners LP: It 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 have maintained their payout, Global Partners is among a minority that has continued to increase distributions through the coronavirus-induced downturn.
The Zacks Rank #1 (Strong Buy) stock’s estimated distribution yield (at 55 cents per quarter) is 9.5%. Moreover, Global Partners’ distribution coverage ratio of 2.4X implies a sufficiently covered payout with room for growth. Over the past 30 days, Global Partners has seen the Zacks Consensus Estimate for its 2021 earnings improve 83.5%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Price and Consensus: GLP
CrossAmerica Partners LP: Wholesale distributor of motor fuels CrossAmerica Partners’ variable rate margins have helped it offset the loss in volumes. Further, the partnership’s recent acquisitions of retail and wholesale assets provide it with a wider reach and scale.
CrossAmerica Partners has a good earnings surprise history, having beaten the Zacks Consensus Estimate in three of the last four quarters and missing in the other, delivering an earnings surprise of 97.72%, on average. The midstream operator carries a Zacks Rank #2 (Buy) and pays out a quarterly distribution of 52.50 cents per unit. At the current price of $18.78, this gives CrossAmerica Partners an annualized distribution yield of 11.2%.
Price and Consensus: CAPL
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, the partnership enjoys stable demand for its services.
Sunoco pays out 82.55 cents quarterly distribution ($3.302 per unit annually), which gives it a 10.3% yield at the current unit price. The MLP carries a Zacks Rank #3 (Hold). The 2021 Zacks Consensus Estimate for Sunoco indicates 407.89% earnings per unit growth over 2020.
Price and Consensus: SUN
Suburban Propane Partners: One of the largest marketers of propane in the United States, the partnership’s operational efficiencies and successful customer base retention should stand it in good stead. Over the past few years, Suburban Propane Partners has diversified its platform through accretive acquisitions.
Suburban Propane pays out 30 cents quarterly distribution ($1.20 per unit annually), which gives it a 7.7% yield at the current unit price. The MLP carries a Zacks Rank #3. The fiscal 2021 Zacks Consensus Estimate for Suburban Propane indicates 31.96% earnings per unit growth over fiscal 2020.
Price and Consensus: SPH
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