If you’re an investor looking for high-yield investments with some solid upside potential, there is perhaps no better place to look than the energy midstream space. The stocks in the space tend to have attractive yields, while the sector as a whole trades below historical multiples.
The sector has gone through a transformation in the past decade, with midstream companies reducing leverage and being more disciplined when it comes to funding growth projects. By and large, the companies structured as master limited partnerships (MLPs) have also eliminated their IDRs (incentive distribution rights), which essentially acted as a tax paid to their general partners every time they increased their distributions.
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Despite the companies being in better financial shape today than under the old MLP model, the stocks trade at a discount to the 13.7 multiple that midstream MLPs traded at between 2011 and 2016.
Against that backdrop, let’s look a three great MLPs — Enterprise Products Partners (NYSE: EPD), Energy Transfer (NYSE: ET), and Western Midstream (NYSE: WES) — investors might want to consider buying and holding forever. All three stocks trade well below the MLP average multiple from that 2011-to-2016 period.
If you’re looking for consistency, there is perhaps no better option in the midstream space than Enterprise Products Partners, which has increased its distribution for 26 straight years during all types of economic and energy environments, and has been a consistent performer throughout the years. The midstream MLP currently has a forward yield of about 6.5%.
The company’s great track record can be attributed to its largely fee-based model as well as its conservative nature with leverage and capital expenditure (capex) spending. It has a well-covered distribution based on its distributable cash flow (DCF), which is operating cash flow minus maintenance capex. Based on that measure, it had a distribution coverage ratio of 1.7 times in the last quarter.
Meanwhile, Enterprise is starting to ramp up its growth projects after pulling back during the pandemic. Enterprise has also said it is one of the best-positioned companies to benefit from increased natural gas and power demand stemming from the artificial intelligence (AI)-driven data center buildout given its pipeline and storage assets.
Despite having arguably one of the most attractive integrated midstream footprints in the U.S., Energy Transfer’s stock is among the cheapest in the space. That’s partly because the company ran into trouble during the pandemic and decided to slash its distribution in half to decrease leverage and improve its balance sheet (which it has achieved).
Since then, the company has been able to increase its distribution to levels above where it was when it was cut, and it plans to raise the distribution by 3% to 5% a year moving forward. The stock currently has a forward yield of about 6.8%.
Given its assets in the Permian basin and access to the cheap associated natural gas produced in the region, Energy Transfer is also very well positioned to take advantage of increasing demand for natural gas to help power AI-focused data centers. Associated natural gas is produced along with crude oil and is generally not the primary reason why an area is being drilled.
Associated Permian gas is pretty abundant, and there are not enough outlets to transport it out of the basin, which leads to very cheap regional pricing. Oil companies sometimes just flare the gas (burn it off), but given the environmental impacts, there are limits.
Energy Transfer has said it is seeing a lot of project requests around its natural gas pipeline network, having received requests to connect to about 45 power plants that it does not currently serve in 11 states and more than 40 prospective data centers in 10 states.
With a yield of about 9.2%, Western Midstream has one of the most attractive yields in the midstream space. Even better, the company has said it could pay excess distributions once its leverage is below 3 times and it has excess free cash flow. The company achieved both criteria in the third quarter, which could lead to its first enhanced distribution in the first quarter of 2025.
While the company could see its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) decline a bit next year due to divesting some assets and a $20 million reduction from a contract change in the Denver-Julesburg basin, the company is still in a good spot with more than half of its EBITDA coming from the prolific Delaware basin.
With its leverage now below 3 times, the company is also well positioned to increase its growth capex to drive future growth. Its strong financial position also gives it the opportunity to make any bolt-on accretive acquisitions that may present themselves.
Given its high yield, low leverage, and strong position in the Delaware basin, Western Midstream is a great option for investors to buy and hold.
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Geoffrey Seiler has positions in Energy Transfer, Enterprise Products Partners, and Western Midstream Partners. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
3 Midstream Stocks to Buy With $5,000 and Hold Forever was originally published by The Motley Fool
Source: finance.yahoo.com