The Zacks Oil and Gas - Pipeline MLP industry comprises master limited partnerships (or MLPs) that are primarily engaged in transporting oil, natural gas, refined petroleum products and natural gas liquids (NGL). The services provided by the partnerships also entail the gathering and processing of commodities.
It is to be noted that MLPs are different from companies as interests in MLPs are considered units (not shares) and unitholders are partners in the business.
Here are the industry’s three major themes:
- Oil price is unlikely to recover before May, when waivers of sanctions on Iranian oil imports issued by the United States to several countries are slated to expire. However, the global economy, which is slowing at an accelerating rate, could offset the pricing recovery. This volatility in crude prices is likely to convince U.S. shale drillers to curtail spending, which in turn will slow domestic oil production growth through 2019, per oilfield service giant Schlumberger Limited (SLB). Slowing shale oil production volumes could affect demand for pipeline and storage properties.
- In 2018, West Texas crude producers could not transport sufficient oil volumes to the Gulf Coast areas — where majority of refineries in the United States are located — because of a pipeline bottleneck problem. Notably, the constraint in transportation capacities is unlikely to get solved before late-2019, when new pipeline projects will start getting operational. Hence, with insufficient pipeline networks, the partnerships are losing opportunities to transport more crude volumes, in turn affecting cash flow.
- To address the bottleneck problem, more transportation networks will be reportedly built in the coming years than required. This is likely to lower the rates charged by the partnerships from the shippers or producers for transporting commodities. Like oil, natural gas producers are facing constraints in transportation networks. Moreover, a slowdown in global economic growth may hurt clean energy needs and in turn lower demand for midstream assets transporting natural gas.
Zacks Industry Rank Indicates Rough Times Ahead
The Zacks Oil and Gas - Pipeline MLP industry is a 17-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #220, which places it at the bottom 15% 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 bleak 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 bottom 50% of the Zacks-ranked industries is a result of cloudy earnings prospects for the constituent partnerships in aggregate. Looking at the aggregate earnings estimate revision, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since May 31, 2018, the industry’s earnings estimates for the current year have moved roughly 3.4% down.
Despite the bleak near-term industry prospects, we present a few stocks that are witnessing positive earnings estimate revisions or are expected to see year-over-year earnings growth. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.
Industry Lags S&P 500, Outperforms Sector
The Zacks Oil and Gas - Pipeline MLP industry has lagged the Zacks S&P 500 composite over the past year. However, the industry has outperformed the broader Zacks Oil - Energy Sector over the same time frame.
The industry has declined 8.9% over this period compared to the S&P 500’s fall of 6.3% and broader sector’s decline of 15%.
One-Year Price Performance
Industry’s Current Valuation
Since midstream-focused oil and gas partnerships use fixed rate debt for the 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 stocks, 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 11.92X, higher than the S&P 500’s 10.38X. It is also significantly above the sector’s trailing-12-month EV/EBITDA of 5.17X.
Over the past five years, the industry has traded as high as 18.95X, as low as 11.04X, with a median of 14.19X.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio
The industry’s balance sheet is significantly levered as compared to the sector and S&P 500 index. As of Sep 30, 2018, the industry’s cash & equivalents were recorded at only $198 million while total debt — both long and short term — stood at more than $19 billion, reflecting balance sheet weakness.
Overall, the expected lower transportation demand, following the probable slowdown in domestic production growth, along with the prevailing pipeline bottleneck problem has been affecting the cashflow of partnerships.
Here, we present a few stocks which are well positioned to grow.
Shell Midstream Partners LP (SHLX): The partnership is engaged in operating extensive pipeline networks in the United States. Shell Midstream carries a Zacks Rank #2 (Buy) and has an expected earnings growth of 27.5% for 2019. Over the past 90 days, the partnership has seen the Zacks Consensus Estimate for 2019 increase 15.4%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price and Consensus: SHLX
Enterprise Products Partners LP (EPD): This Houston-Texas based partnership is among the leading providers of services associated with transportation of storage of natural gas and oil. The #3 (Hold) Ranked stock has an expected earnings growth of 5.2% for 2019. Over the past 90 days, the partnership has seen the Zacks Consensus Estimate for 2019 move 2.1% up.
Price and Consensus: EPD
Plains All American Pipeline LP (PAA): This midstream energy player’s services include transportation of oil and natural gas. Plains All American carries a Zacks Rank #3 and has an expected earnings growth of 13.2% for 2019. Over the past 90 days, the partnership has seen the Zacks Consensus Estimate for 2019 remain static.
Price and Consensus: PAA
NuStar Energy LP (NS): The partnership has an extensive crude oil pipeline network that spreads over 9,800 miles. The Zacks #3 Ranked stock has an expected earnings growth of 148.3% for 2019. Over the past 90 days, the partnership has seen the Zacks Consensus Estimate remain at the same position.
Price and Consensus: NS
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