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4 Stocks to Buy as Refining & Marketing MLP Industry Stages a Rebound

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While coronavirus-related uncertainty and concerns continue to weigh on the Zacks Oil and Gas - Refining & Marketing MLP industry, the defensive nature of the space and its fee-based business model has held up relatively well even in a falling price environment.

With the commodity markets now showing signs of stability and volumes through pipelines slowly rising back, industry players like Western Midstream Partners, LP: (WES - Free Report) , Sunoco LP (SUN - Free Report) , Suburban Propane Partners, L.P. (SPH - Free Report) and CrossAmerica Partners LP (CAPL - Free Report) are expected to benefit.

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 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).

4 Trends Defining the Oil and Gas - Refining & Marketing MLP Industry’s Future

Pipeline Stocks Provide a Defensive Option: Considering the uncertainty in oil right now, 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.

Lower Volumes Flowing 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 other 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, the MLPs are facing volume contraction through their facilities, contributing to lower profits. Though some of the production shut-ins have returned in response to gradually tightening fundamentals, the rapidly rising new coronavirus cases around the world — leading to reimposition of lockdowns — mean a renewed threat to oil demand and midstream volumes.

Distributions Remain Reasonably Safe: Investors are typically attracted to the MLPs thanks to their 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 their cash outflows. Adjusting costs with reduced business activity, the partnerships have concentrated on the generation of free cash flow (post distribution payment) to lower debt and strengthen their financial position.

Virus Resurgence Hampers Demand Recovery: Per the U.S. Energy Department's latest inventory release, gasoline and distillate inventories are 3% and 17% above their respective five-year averages for this time of year, signaling plenty of oil products available in the market. Therefore, fuel margins (or crack spreads) remain depressed. Further, the reimposition of government measures to fight the spread of the pandemic’s second wave could cause another consumption slowdown. In particular, with new travel restrictions across Europe and the United States, 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 Bright 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 #114, which places it in the top 46% 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 bullish 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 positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are optimistic on this group’s earnings growth potential. While the industry’s earnings estimates for 2020 have increased 32% in the past six months, the same for 2021 have improved 16% over the same timeframe.

Taking into account 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 Lags Sector & S&P 500

The Zacks Oil and Gas - Refining & Marketing MLP industry has lagged the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.

The industry has declined 56.9% over this period compared to the S&P 500’s gain of 10.1% and broader sector’s decrease of 44.8%.

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 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 7.02X, lower than the S&P 500’s 14.12X. It is, however, significantly above the sector’s trailing-12-month EV/EBITDA of 3.95X.

Over the past five years, the industry has traded as high as 17.34X, as low as 6.69X, with a median of 13.15X, 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 That Could Deliver Solid Returns

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 12.5% yield at the current unit price. The MLP carries a Zacks Rank #1 (Strong Buy). Over the past 30 days, Sunoco has seen the Zacks Consensus Estimate for 2020 improve 6.3%.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: SUN



CrossAmerica Partners LP: Wholesale distributor of motor fuels CrossAmerica Partners’ variable rate margins have helped it to offset the loss in volumes. Further, the partnership’s recent acquisitions of retail and wholesale assets provide it with a wider reach and scale.

The 2020 Zacks Consensus Estimate for CrossAmerica Partners indicates 376.5% earnings per unit growth over 2019. 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 $14.30, this gives CrossAmerica Partners an annualized distribution yield of 14.7%.

Price and Consensus: CAPL



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 an 8% yield at the current unit price. The MLP carries a Zacks Rank #2. Over the past 30 days, Suburban Propane has seen the Zacks Consensus Estimate for FY 2020 improve 6.3%.

Price and Consensus: SPH



Western Midstream Partners, LP: The partnership is engaged in gathering, processing, compressing, treating, and transporting natural gas, condensate, natural gas liquids, and crude oil. Its top class asset portfolio, financial strength and ability to generate stable cash flows should boost unitholder returns.  

Over the past 30 days, Western Midstream Partners has seen the Zacks Consensus Estimate for 2020 improve 3.1%. The midstream operator carries a Zacks Rank #2 and pays out a quarterly distribution of 31.10 cents per unit. At the current price of $7.87, this gives Western Midstream Partners an annualized distribution yield of 15.8%.

Price and Consensus: WES



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