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Near-Term Outlook for Oil & Gas Pipeline Stocks Appears Dull

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The Zacks Oil and Gas - Production & Pipelines industry comprises companies and some partnerships that own and operate midstream energy infrastructure assets. The properties consist of extensive pipeline networks that transport crude oil, liquids and natural gas. The midstream energy players are also involved in processing and storing natural gas. Moreover, the companies have interests in natural gas distribution utilities and thereby serve millions of retail customers across North America.

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

  • Lower drilling and fracking activities owing to conservative capital spending by explorers have slowed down onshore North American crude production. Moreover, the decision of the drillers to cut spending for the second successive year in 2020, since they are struggling to generate profit from shale plays, have intensified concerns. This is likely to reduce transportation volumes of the commodity, affecting the partnership’s fee-based revenues.
  • A constraint in transportation capacities in the U.S. shale plays has been keeping explorers from producing at optimum levels. Although new and extended pipelines are coming online, it still requires more pipeline networks to completely eradicate the bottleneck problem. Thus, the midstream energy firms are still losing out on the opportunity to transport more crude volumes.
  • The balance sheets of the pipeline companies are loaded with debt, while cash balances remain relatively nominal. This may constrain their capacities to invest in future projects and hence dent possibilities of incremental fee-based revenues.

Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Oil and Gas - Production & Pipelines industry is part of the broader Zacks Oil - Energy sector. It carries a Zacks Industry Rank #200, which places it at the bottom 21% 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 negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth potential. Over the past year, the industry’s earnings estimate for the current year has gone down almost 2%.

Before we present a few midstream energy stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock market performance and current valuation.

Industry Lags S&P 500 but Outperforms Sector

The Zacks Oil and Gas - Production & Pipelines industry has lagged the Zacks S&P 500 composite over the past year but has outperformed the broader Zacks Oil - Energy sector over the same period.

The industry has risen 2.3% in the past year versus the S&P 500’s rise of 19% and the broader sector’s fall of 10.3%.

One-Year Price Performance

Industry’s Current Valuation

Since midstream energy players are debt-laden, 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.

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, the industry is currently trading at 13.09X, higher than the S&P 500’s 11.40X. It is also significantly above the sector’s trailing-12-month EV/EBITDA of 4.88X.

Over the past five years, the industry has traded as high as 26.29X, as low as 10.25X, with a median of 13.43X.

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

Bottom Line

Debt-heavy balance sheets and American drillers’ conservative stance toward capital spending are bothering midstream energy players. However, some relief is expected in the approaching winter season when demand for natural gas distribution rises.

We are presenting one stock with a Zacks Rank #2 (Buy), with the following four carrying a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Enbridge Inc ENB: The company is the operator of the longest pipeline network of liquids in the world. The Zacks Consensus Estimates for this company’s 2019 and 2020 earnings per share have been revised upward in the past 30 days.

Price and Consensus: ENB

Kinder Morgan Inc. KMI: The company has the largest network of natural gas pipeline in North America that spreads across almost 70,000 miles. Through 2019 and 2020, the company is likely to see earnings growth of 8% and 3%, respectively.

Price and Consensus: KMI

Williams (WMB - Free Report) : The leading natural gas infrastructure company is likely to see earnings growth of 25.3% and 6% in 2019 and 2020, respectively. The stock has witnessed positive earnings estimate revision for 2019 and 2020.

Price and Consensus: WMB

Pembina Pipeline Corporation PBA: The company is a leading midstream energy player in North America. For 2019, the stock is likely to see earnings growth of almost 17%.

Price and Consensus: PBA

Holly Energy Partners LP HEP: The partnership is the owner and operator of pipelines for crude oil and petroleum products. The stock is likely to see earnings growth of 15% in 2019.

Price and Consensus: HEP

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