Oil and Gas - Refining & Marketing MLP industry should benefit in the near term from the ongoing recovery in energy usage. With the commodity markets now showing signs of stability and volumes through pipelines slowly coming back, the conservative, income-seeking investors might want to focus on the fee-based business models of Targa Resources Corp. ( TRGP Quick Quote TRGP - Free Report) , Sunoco LP ( SUN Quick Quote SUN - Free Report) , Global Partners LP ( GLP Quick Quote GLP - Free Report) and NGL Energy Partners LP ( NGL Quick Quote NGL - Free Report) . 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 MLPs typically distribute nearly all of their cash flows back to their unitholders. The assets that these partnerships own are primarily 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 sell refined products (like heating oil, gasoline, residual oil, jet fuel etc.) and a plethora of non-energy materials (like asphalt, road salt, clay, gypsum).
3 Trends Defining the Oil and Gas - Refining & Marketing MLP Industry's Future
Considering the volatility in oil right now — especially after the OPEC+ cartel’s recent agreement to gradually start raising output from August to the pre-pandemic levels — a safer way of playing the sector would be to utilize MLPs, which offer considerable returns at 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. Pipeline Stocks Provide a Defensive Option: 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 last year’s 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 presents a risk for midstream volumes and re-contracting terms for pipeline operators. Moreover, even though fuel usage has recovered on increased mobility — reflected by rising refinery utilization and margin numbers — jet fuel demand is yet to reach the pre-pandemic levels. Thus, refining profitability is still well below the five-year averages. Continued Threat to Volumes: 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 — managed to maintain their distribution levels through the crisis-stricken 2020. Further, their relatively steady coverage and improving commodity 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 the financial position. The growing free cash flows could be used to boost investor returns through buybacks and distribution hikes. Prioritize Distribution Growth: Zacks Industry Rank Indicates Positive Outlook
The Zacks Oil and Gas - Refining & Marketing MLP is an 11-stock group within the broader Zacks
Oil - Energy sector. The industry currently carries a Zacks Industry Rank #112, which places it in the top 44% 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 an improving 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 2021 have increased 22.7% in the past year, the same for 2022 have risen 3.9% 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 57.6% over this period compared to the S&P 500’s rise of 33.1% and broader sector’s increase of 20.6%. 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 non-cash expenses.
On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, the industry is currently trading at 9.81X, significantly lower than the S&P 500’s 17.58X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 5.30X. Over the past five years, the industry has traded as high as 17.82X, as low as 6.74X, with a median of 12.80X, 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
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 2021 Zacks Consensus Estimate for Targa Resources indicates 117.22% earnings per share growth over 2020. The midstream operator, which has a large presence in the booming Permian Basin, carries a Zacks Rank #1 (Strong Buy). In 2021, Targa Resources shares have surged 62.4%. Price and Consensus: TRGP
NGL Energy Partners LP: It is an MLP that owns water disposal wells, the Grand Mesa oil pipeline, and a wholesale propane/butane business. NGL Energy Partners has done a fairly admirable job at reducing costs. Its cash outflows as capital expenditure continue to fall as it keeps spending levels in check. Apart from significant capital cuts, the partnership should realize sizeable savings from headcount reduction and automation. The fiscal 2022 Zacks Consensus Estimate for NGL Energy Partners indicates 125.17% earnings per unit growth over 2020. The midstream operator, whose stock is down 12.1% so far this year carries a Zacks Rank #2 (Buy). Price and Consensus: NGL
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 the minority that has continued to increase distributions through the coronavirus-induced downturn. The Zacks Rank #3 (Hold) stock’s estimated distribution yield (at 57.50 cents per quarter) is 9.4%. Moreover, Global Partners’ distribution coverage ratio of 2.04X implies a sufficiently covered payout with room for growth. Global Partners boasts a good earnings surprise history. It surpassed estimates in three of the last four quarters and missed in the other, delivering an earnings surprise of 245.26%, on average. Meanwhile Global Partners units have gained 47.4% year to date. Price and Consensus: GLP
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 9.1% yield at the current unit price. The 2021 Zacks Consensus Estimate for this #3 Ranked MLP indicates 635.53% earnings per unit growth over 2020. The Sunoco stock has gained 26.2% in 2021. Price and Consensus: SUN