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Is Oil & Gas Refining & Marketing MLP Industry Turning the Corner?

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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, 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:

•    Gasoline sales in the United States continued to tick up in recent weeks in a recovery from historic lows as the economy reopened and lockdown measures imposed to curb the coronavirus pandemic were eased. Further, oil product demand in China - the world’s second-largest energy consumer - has been gradually increasing. While overall usage remains well below pre-virus levels and stockpiles continue to swell, the refining and marketing operators should benefit from increased utilization that will also have a favorable impact on profitability.

•    Most MLPs derive their revenues based on the amount of fuel transported and are relatively insulated from oil/gas and refined product price fluctuations. The defensive, fee-based business model not only provides cash flow stability to the refining and marketing MLPs through the boom and bust cycle, but also has a lower risk profile. 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. Even within the fee-based contracts, a significant portion is of take-or-pay type - meaning the MLPs get paid irrespective of the volume of commodities that gets transported.

•    Investors are typically attracted to the MLPs thanks to their reliable distributions and defensive characteristics. But this time, things seem to be different as the plunge in global commodity prices is forcing them to realign their strategy. A reliable high-yield income choice till recently, a number of sector components had to slash their quarterly payouts to weather the historic price crash and preserve cash. These cuts are set to deal a heavy blow to income investors, who held the stocks for their above-average distribution yield and the security to sustain the payments.

Zacks Industry Rank Indicates Bullish 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 #52, which places it in the top 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 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 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 8% in the two months, the same for 2021 have improved 6% over similar timeframe.

Despite 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 42.3% over this period compared to the S&P 500’s gain of 4% and broader sector’s decrease of 38.3%.

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 7.81X, lower than the S&P 500’s 11.11X. It is, however, significantly above the sector’s trailing-12-month EV/EBITDA of 3.94X.

Over the past five years, the industry has traded as high as 18.12X, as low as 6.74X, with a median of 13.53X, as the chart below shows.

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

Bottom Line

Just like all other energy subsectors, refining and marketing MLPs have been greatly affected by the coronavirus crisis, which has led to a collapse in the demand for jet fuel and gasoline.

But it seems that crude’s worst losses are in the rear view mirror with signs of gradual rebalancing. While the OPEC+ group has started to withhold output by almost 10 million barrels per day – the largest in history – from May 1, U.S. shale oil production is set to tumble in 2020 on reduced capital availability. Finally, greater financial discipline practiced by the energy companies has raised expectations that supply growth could slow down sooner than later even as fuel demand picks up on easing lockdown measures.

In fact, the International Energy Agency also said global demand would rebound to an average of 97.4 million bpd in 2021. It is about 5.7 million bpd higher than this year and the biggest annual jump ever.

As mentioned above, gasoline consumption is already on its way up with more and more people getting, leading to higher road traffic. This, in turn, will bolster cash flow generation at the partnerships with downstream exposure.

With the abovementioned catalysts set to provide near-term upside, we are presenting three stocks with a Zacks Rank #1 (Strong Buy) and another with a Zacks Rank #2 (Buy) that are well positioned to gain.

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

Calumet Specialty Products Partners, L.P. (CLMT - Free Report) : Calumet Specialty Products Partners focused on the production of high-quality, specialty products and fuels in North America. Over 30 days, the Indianapolis, IN-headquartered partnership – carrying a Zacks Rank #1 – has seen the Zacks Consensus Estimate for 2020 improve 11%.

Price and Consensus: CLMT

NGL Energy Partners LP (NGL - Free Report) : This diversified downstream energy partnership focuses on four primary businesses: water solutions, crude oil logistics, NGL logistics, and refined products/renewables. NGL Energy Partners carries a Zacks Rank #1 and has seen the Zacks Consensus Estimate for 2020 surge 281% over 30 days.

Price and Consensus: NGL

Sprague Resources LP (SRLP - Free Report) : Sprague Resources, engaged in the purchase, storage, distribution and sale of refined petroleum products and natural gas, carries a Zacks Rank #1 and has an attractive expected earnings growth of 64.6% for this year.

Price and Consensus: SRLP

Targa Resources Corp. (TRGP - Free Report) : Based in Houston, TX, Targa Resources is a leading provider of integrated midstream services in North America. The company carries a Zacks Rank #2 and has surpassed estimates in three of the last four quarters, the average being 267.7%.

Price and Consensus: TRGP

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