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, jet fuel 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:
- Since the last Industry Outlook, U.S. inventory data has shown significant supply build for gasoline and distillate inventories, signaling plenty of oil products available in the market. Therefore, margins continue to remain depressed despite steady demand. Further, the deadly coronavirus outbreak in China has weakened demand from the world’s second largest energy consumer. In particular, with major cities under lock-down and travel restrictions in place, the consumption of jet fuel (a derivative of distillates) is set to drop substantially. This will not only affect refining profitability but also result in increased price volatility.
- Most MLPs derive their revenues 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 makes long-term distribution growth more predictable. Since the revenues they earn are volume-driven and often under long-term contracts, pipeline operators are likely to enjoy stable demand for their services even if the U.S. economy slows.
- The downstream refining and marketing MLPs tend to get a major portion of their cash flows from gasoline distribution and retail operations. These businesses are quite stable and defensive thanks to highly inelastic gasoline sales and demand. Consumption of gasoline is a necessity and remains resilient even during lean times as consumers would still need to drive and fill up the tank. In fact, the current low oil price environment influences people to drive and travel more, which boosts gasoline demand. Lower fuel expense also leaves consumers with a larger disposable income that they can utilize on retail store purchases.
Zacks Industry Rank Suggests Challenging 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 #191, which places it in the bottom 25% 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 dim 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 on this group’s earnings growth potential. As a proof of this, the industry’s earnings estimate for 2020 have decreased 8.8% in the past year.
Despite the bleak 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 But Lags S&P 500
The Zacks Oil and Gas - Refining & Marketing MLP industry has outperformed the broader Zacks Oil - Energy Sector over the past year but has lagged the Zacks S&P 500 composite over the same period.
The industry has declined 10% in the past year compared with the S&P 500’s gain of 18.6% and broader sector’s decrease of 19.2%.
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 12.09X, lower than the S&P 500’s 12.31X. It is, however, significantly above the sector’s trailing-12-month EV/EBITDA of 4.72X.
Over the past five years, the industry has traded as high as 21.85X, as low as 9.84X, with a median of 13.90X, as the chart below shows.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio
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 (or the difference between the price of oil and refined products).
Therefore, given the current weakness in oil (the input for refiners), 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.
However, the health scare and the resulting economic uncertainty caused by the coronavirus have led to fears of lesser driving in the region (China and several Asian countries), translating into lower oil product demand. Consequently, the freed-up domestic barrels could find their way to the export market and weaken the fundamentals.
Despite the current downbeat mood in the industry, we are presenting three stocks with a Zacks Rank #2 (Buy) that are well positioned to gain amid the prevailing challenges. There is also a stock with a Zacks Rank #3 (Hold) that investors may currently retain in their portfolio.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Western Midstream Partners, LP (WES - Free Report) : Western Midstream Partners is engaged in gathering, processing, compressing, treating, and transporting natural gas, condensate, natural gas liquids, and crude oil. The firm’s expected EPU growth rate for three to five years currently stands at 6%, comparing favorably with the industry's growth rate of 4.6%. The partnership carries a Zacks Rank of 2.
Price and Consensus: WES
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. The midstream operator – carrying a Zacks Rank #2 – has seen the Zacks Consensus Estimate for 2020 increase 2.6% over 30 days.
Price and Consensus: PSXP
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 #2 and has an expected earnings growth of 8.5% for this year.
Price and Consensus: SUN
Global Partners LP (GLP - Free Report) : This vertically integrated downstream energy partnership focuses on the distribution of gasoline, distillates, residual oil, and renewable fuels, apart from owning several refined-petroleum-product terminals. The midstream operator carries a Zacks Rank #3 and has seen the Zacks Consensus Estimate for 2020 increase 24.1% over 30 days.
Price and Consensus: GLP