When looking for high-yield stocks in the energy space, there’s no better place to look than the midstream space. Midstream companies are involved in a number of activities, but are largely known for transporting crude oil, natural gas, and NGLs (liquids derived from natural gas) through their networks of pipeline assets.
These pipeline companies generally have minimal exposure to energy prices and are largely capitalizing on increasing hydrocarbon volumes. On that front, the midstream industry could be a major beneficiary of the proliferation of generative artificial intelligence (AI) in data centers, as AI applications consume a tremendous amount of energy.
In fact, Boston Consulting Group predicts that data centers could account for as much as 7.5% of total US electricity consumption by 2030. As new data centers are built to meet this demand, they will need to be almost cheaper sources of natural gas, and with their increased energy consumption will come greater volumes of natural gas pipelines.
Let’s take a look at two high-yield midstream stocks that could benefit from this AI energy consumption trend that investors should buy now.
1. Energy transfer
With nearly 90,000 miles of pipelines, 235 billion cubic feet (bcf) of operating storage capacity and more than 65 natural gas processing and treatment facilities, Energy transfer (NYSE:ET) is one of the largest natural gas transporters in North America. The company has the largest integrated midstream system in the US, covering virtually all points of the midstream process from the wellbore to the final destination.
Permian natural gas is among the cheapest in the U.S. because drilling for oil draws energy-hungry data centers to the region. With AI’s increased natural gas consumption, Energy Transfer is positioned for expansion projects of the existing Permian system to supply natural gas to meet the increased energy needs of these data centers.
Meanwhile, the company is in one of the best financial conditions in its history, with a solid balance sheet and very well-covered distribution. The Master Limited Partnership (MLP) has a yield of 8.2% based on its most recent quarterly distribution, and plans to increase this by 3% to 5% per year going forward.
The stock trades at 7.3 times on an enterprise value (EV) to forward EBITDA basis and is attractively valued both compared to its mid-market peers and on a historical basis. I prefer to use this metric when valuing midstream companies because it takes into account their debt and excludes non-cash items such as depreciation.
Given Energy Transfer’s valuation, its strong balance sheet, and the potential growth opportunities coming from increased AI energy consumption, this seems like a smart stock to invest $1,000 or more in right now, as it offers both high returns and strong price appreciation potential.
2. Kinder Morgan
With approximately 67,000 miles of natural gas pipeline, Kinder Morgan (NYSE: KMI) transports approximately 40% of the natural gas consumed in the United States. It also has 702 bcf of operating storage capacity, which is about 15% of US capacity. With a solid set of assets in the Permian and throughout Texas, the company is also well poised to capitalize on growing demand for natural gas from data centers in the area.
Kinder Morgan’s management focused on the positive impact AI energy consumption would have on its business during its latest earnings conference call. It said utilities across North America are “sounding the alarm” about increased energy consumption coming from data centers and that natural gas would play a major role in power generation to meet this increasing demand. The company said it was already working with a Southeast utility company that wanted to connect to its system, given the need for a reliable power supply.
The company is well prepared to avoid commodity price fluctuations; 68% of cash flow comes from take-or-pay or hedged contracts where volumes and prices are fixed, and 27% from fee-based contracts where prices are fixed and volumes are variable. Only 5% of cash flow comes from activities exposed to commodity prices.
The stock trades at 9.5x on an enterprise value (EV) to forward EBITDA basis and is attractively valued when looking at its recent history. Unlike Energy Transfer, Kinder Morgan is structured as a corporation. So the financial structure doesn’t require shareholders to file a Schedule K-1, which some investors don’t like because of the extra paperwork involved at tax time. The stock currently has a yield of 5.8%.
Overall, Kinder Morgan is another solid, high-yield pipeline that is well positioned to benefit from increasing demand for natural gas from AI. As such, the stock looks like another smart buy.
Do you now have to invest € 1,000 in energy transfer?
Consider the following before purchasing shares in Energy Transfer:
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Geoffrey Seiler has positions in Energy Transfer. The Motley Fool holds and recommends positions in Kinder Morgan. The Motley Fool has a disclosure policy.
The Smartest High-Yield Energy Stocks You Can Buy Right Now with $1,000 was originally published by The Motley Fool
