If you’re an investor looking for investments with high returns and solid upside potential, there may be no better place to look than the energy midstream space. Stocks in this sector tend to have attractive yields, while the sector as a whole is trading below historical multiples.
The sector has undergone a transformation over the past decade, with midstream companies reducing debt and being more disciplined when it comes to financing growth projects. Generally, 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 whenever they increased their distributions.
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Despite the companies being in better financial shape today than under the old MLP model, the shares trade at a discount to the 13.7 multiple at which midstream MLPs traded between 2011 and 2016.
Against that backdrop, let’s take a look at three great MLPs: Partners for business products (NYSE:EPD), Energy transfer (NYSE:ET), and Western Midstream (NYSE: WES) – Investors might consider buying and holding forever. All three stocks trade well below the MLP average for the 2011-2016 period.
If you’re looking for consistency, there may be no better option in the midstream space than Enterprise Products Partners, which has expanded its distribution for 26 years in a row across all types of economic and energy environments, and has maintained consistent performance over the years delivered. . The midstream MLP currently has a forward yield of approximately 6.5%.
The company’s excellent track record can be attributed to its largely fee-based model and the company’s conservative nature in terms of leverage and capital expenditure (capex). It has a well-covered distribution based on distributable cash flow (DCF), which consists of operating cash flow minus maintenance investments. Based on that benchmark, it had a benefit coverage ratio of 1.7 times in the past 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 demand for natural gas and energy due to the artificial intelligence (AI)-driven data center buildout, given its pipeline and storage resources.
Despite perhaps having one of the most attractive integrated midstream footprints in the US, Energy Transfer’s shares are among the cheapest in the sector. That’s partly because the company ran into trouble during the pandemic and decided to cut its distribution in half to reduce debt and improve its balance sheet (which it has achieved).
Since then, the company has been able to increase its distribution to levels above the level at which it was reduced, and it plans to increase distribution by 3% to 5% per year going forward. The stock currently has a forward yield of approximately 6.8%.
Given its assets in the Permian Basin and access to the low-cost associated natural gas produced in the region, Energy Transfer is also very well positioned to take advantage of increasing demand for natural gas to power AI-focused data centers. Associated natural gas is produced along with crude oil and is generally not the primary reason for drilling in an area.
Associated Permian gas is quite abundant, and there are not enough outlets to transport it out of the basin, leading to very cheap regional prices. Oil companies sometimes simply flare (burn off) the gas, but given the environmental impact, there are limits.
Energy Transfer has said it is seeing a lot of project requests around its natural gas pipeline network as it has received requests to connect to about 45 power plants it does not currently serve in 11 states and more than 40 future data centers in 10 states.
With a yield of approximately 9.2%, Western Midstream has one of the most attractive yields in the midstream space. In fact, the company has said it could pay excess distributions once leverage is less than three times and there is excess free cash flow. The company met both criteria in the third quarter, which could lead to the first improved distribution in the first quarter of 2025.
Although the company could see its adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) decline slightly next year due to the divestiture of some assets and a $20 million discount from a contract change at the Denver-Julesburg- basin, the company is still in a good place, with more than half of its EBITDA coming from the fertile Delaware Basin.
With leverage now below 3x, the company is also well positioned to increase its growth investments to fuel future growth. The strong financial position also gives the company the opportunity to make additional acquisitions that may arise.
Given its high yield, low debt burden, and strong position in the Delaware Basin, Western Midstream is a great option for investors to buy and hold.
Consider the following before purchasing shares in Energy Transfer:
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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 one disclosure policy.
3 Midstream Stocks to Buy with $5,000 and Hold Forever was originally published by The Motley Fool
