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Oil & Gas Refining & Marketing MLP Industry to Grow on Strong Demand

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Master limited partnerships (or MLPs) differ from regular stocks in that 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 typically are 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, etc.) and a plethora of non-energy materials (like asphalt, road salt, clay, and gypsum).

Let’s take a look at the industry’s three major themes:

  • The fortunes of downstream refining and marketing MLPs are tied to the underlying developments in their business. Therefore, with annual average demand for gasoline – the most widely used petroleum product – set to reach the highest on record this year, the industry operators should be able to benefit from stronger sales volumes. Robust refined product demand will also lead to improvement in earnings and the cash flows.
     
  • Most MLPs derive their revenue based on the amount of fuel transported and are relatively insulated from oil and refined product price fluctuations. The defensive, fee-based business model not only provides cash flow stability to the refining and marketing MLPs but also make long-term distribution growth more predictable. Since the revenues they earn are volume-driven and often under long-term contracts, the pipeline operators are likely to enjoy stable demand for their services even if the U.S. economy slows.
     
  • The sentiment among pipeline investors remains cautious following the FERC policy revision that signaled significant future changes on how the pipeline partnerships will go about treating income taxes in their books of accounts. Partnerships charging cost-based rates for interstate transportation service would have to lower customer tariffs to move oil, gas and refined products around the country by the amount of their income tax allowances — substantial in certain cases. A reduction in cost recovery would likely cut into their cash flows. With the new rule expected to be adopted only by 2020, the issue may remain a thorn in the flesh for the foreseeable future.

Zacks Industry Rank Indicates Favorable Outlook

The Zacks Oil and Gas - Refining & Marketing MLP is a 14-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #102, which places it in the top 40% 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 impressive 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.

Before we present a few stocks that you may want to consider, let’s take a look at the industry’s recent stock-market performance and valuation picture.

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 21.4% over this period compared to the S&P 500’s fall of 5.8% and broader sector’s decrease of 16.8%.

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 11.08X, higher than the S&P 500’s 10.41X. It is also significantly above the sector’s trailing-12-month EV/EBITDA of 5.19X.

Over the past five years, the industry has traded as high as 19.78X, as low as 10.17X, with a median of 13.56X.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

 

 

Bottom Line

The traditional fuels refining operation — where crude is turned into products ranging from gasoline and diesel to jet fuel and asphalt — is heavily dependent on commodity price fluctuations. A tepid oil price environment generally results in the strengthening of crack spreads —difference between the price of oil and refined products.

Therefore, given the current weakness in oil (the input for refiners), product demand is expected to be strong due to low product prices. This, in turn, will bolster cash flow generation at the partnerships with downstream exposure.

We are presenting one stock with a Zacks Rank #1 (Strong Buy) and another three with Zacks Rank #2 (Buy) that are well positioned to grow.

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

Sunoco LP (SUN - Free Report) : This downstream operator focuses on motor fuel distribution to convenience stores, independent dealers and commercial customers. Sunoco carries a Zacks Rank #1 and has an expected earnings growth of 70.4% 2019. Over 90 days, the partnership has seen the Zacks Consensus Estimate for 2019 increase 9.6%.

 

Price and Consensus: SUN

 

CrossAmerica Partners LP (CAPL - Free Report) : This partnership — focused on wholesale motor fuel distribution primarily in the East Coast and Midwest — has a Zacks Rank #2. CrossAmerica Partners has an expected earnings growth of 1,533.33% for 2019. Over 90 days, the partnership has seen the Zacks Consensus Estimate for 2019 increase 91.2%.

Price and Consensus: CAPL

 

NGL Energy Partners LP (NGL - Free Report) : This diversified downstream energy partnership focuses on five primary operating segments: water solutions, crude oil logistics, NGL logistics, refined products/renewables, and retail propane. NGL Energy Partners carries a Zacks Rank #2 and has an expected earnings growth of 226.9% for FY 2019. Over 90 days, the partnership has seen the Zacks Consensus Estimate for FY 2019 increase 187.3%.

Price and Consensus: NGL

 

Phillips 66 Partners LP (PSXP - Free Report) : Phillips 66 Partners owns fee-based crude oil, refined product and NGL pipelines and terminals, in addition to other transportation and midstream properties. Phillips 66 Partners, also having a Zacks Rank #2, has an expected earnings growth of 56.4% for 2018. Over 90 days, the partnership has seen the Zacks Consensus Estimate for 2018 increase 6.6%.

Price and Consensus: PSXP

 

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