Seeking Alpha

Energy Infrastructure: Big Yields, Low Prices, And Double-Digit Total Returns

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Includes: AMLP, AMZA, BIP, BPMP, CRAK, DKL, EDP, ENB, EPD, ET, INF, KMI, MMLP, MMP, MPC, MPLX, NBLX, OKE, OMP, PAA, PSX, TRP, VLO, WMB
by: Thomas Hughes
Thomas Hughes
Long-term horizon, newsletter provider, long/short equity, portfolio strategy
Summary

In Brookfield's 3Q 2019 Real Assets update, the company double-downs on energy infrastructure.

Mid-stream partners have been under heavy pressure due to volatility in the energy markets. This is providing an opportunity for value investors.

Distributions are safe and expected to hold steady, if not increase.

I dig deeper into the midstream sector looking for the best value-for-yield investment opportunities I can find.

You don't want exposure to this sector unless you're looking for double-digit total returns in 2020.

Brookfield, They Believe In Mid-Stream Energy Infrastructure

Thinking about Brookfield's Public Securities Group, I am reminded of a commercial I used to see on TV when I was a kid; "When EF Hutton Talks People Listen". While we are not talking about EF Hutton or brokerage firms, when it comes to real assets, when Brookfield speaks, I listen. Brookfield is one of the top, if not the leading, investment managers when it comes to real assets, and I am interested in real assets. It's that simple.

Brookfield just held its 3rd quarter Real Assets update, and in it, they make a great case for energy infrastructure and specifically the midstream operators. Mid-stream operators are businesses that own and operate pipelines, processing, and storage facilities for petroleum liquids, natural gas, NGLs, petrochemicals, and their associated products. As a dividend-growth investor currently focused on infrastructure, I am naturally interested, so I had to dig deeper. From what I've found, energy infrastructure is poised to deliver double-digit-total returns in 2020.

How Midstream Operators Make Money

There are three Ways Midstream Operators Make Money

1) fees for services such as delivery, storage, processing etc.

2) regulated tariffs for interstate transportation.

3) other related businesses, petrochemicals, etc.

Demand, production, and supply of petroleum liquids, natural gas and related products are trending at record levels and on the rise. A look at data from the EIA confirms world production and demand are on the rise and predict both will hit new highs in 2020. While the supply/demand balance is not expected to deliver a massive rally in oil prices, it is expected to support prices over the long term. Regardless of the price of oil, demand for storage, pipeline services, transport, and delivery will remain high, and those revenues are not tied to the price of oil.

While the midstream group is sensitive to the volatile price of oil, its business model is not dependent on it. Mid-stream operators make their money on volumes supplied or stored, the difference in input costs and prices received, and their businesses are typically protected by long-term contracts. With this in mind, the last year has seen the value of many mid-stream players decline even while the fundamental outlook for profits and distribution growth improve. That is an opportunity for value-minded income investors today.

Midstream Operators, By The Numbers

I have compiled a list of 16 midstream operators for this analysis and have grouped them into three broad categories; MLPs, midstream corporations, and midstream/refineries. For this section, I will be referring to these groups in a broad sense using equally weighted aggregated data.

Own work; data sourced from Seeking Alpha

One of the pillars of Brookfield's investment thesis for the midstream group is a return to growth. The first thing that jumps out at me is that yes, these companies are looking at robust growth in both EPS and revenue next year.

Own work; data sourced from Seeking Alpha

Revenue growth will exceed 5% in all three groups. The slowest growth will be seen in the MLPs, the fastest among the refiners. Revenue growth will result in earnings growth, and in all cases, earnings growth will be double-digits, high double-digits. The slowest earnings growth will be among the midstream corporations, but by slowest, I mean near 20%. The most robust earnings growth will be seen among the refiners, and that's a stunning 61%.

Revenue and earnings growth will drive dividends next year. All three groups are yielding more than double the broad market S&P 500 average, and that's led by the MLPs. The MLPs are delivering about 8.5% right now, and the payments are relatively safe if the revenue and earnings growth estimates are to be believed.

Dividends, Payout Ratios, And Distribution Coverage

Dividends in midstream energy infrastructure are sky-high, high enough to be wary, at least among the MLPs. The MLPs are yielding an average of 8.5% with many in the group delivering double digits. The midstream corporations are paying about half that, 3.5%, and that skewed downward by Cheniere Energy Partners (NYSEMKT:CQP). Taking Cheniere out of the mix, the average yield among midstream corporations rises to 4.6%.

The midstream/refiners are also yielding about 3.5%, but that is offset by other factors. The refiners are expecting the most robust revenue and earnings growth next year. They have the healthiest payout ratios and a double-digit outlook for distribution growth.

Pixabay CC 0.0

There are quite a few dividend-growers among the grouping, but those figures can be misleading. The MLP distributions, in particular, are sensitive to earnings due to their tax-exempt status. Many of them have had to cut or chosen to cut their distributions in recent years, so the growth history is limited. One, Enterprise Products Partners, LP (EDP) has been increasing its distribution for 20 years and two more are in the 15-20 year-range, so it really comes down to company specifics.

This is also true of MLP payout ratios. The ratios look high at first glance, but company specifics play a big role in distribution health. While payout ratios can be an inverse to coverage ratios, the correlation is not one to one. Distribution coverage for the MLPs is summed up well in Bryce Bingham's article MLP Q2 2019 Distribution Coverage And Payout Ratios Provide Peace Of Mind.

Basically, coverage ratios have been improving in recent years due to several factors. These factors include improvements in Incentive Distribution Rights, use of leverage, and a shift to self-funding capital improvements & expansions. Most MLPs are earning at least 1.1X times their annual distributions with many safely above 1.2X earnings.

The MLPs Which Are Most Attractive Now

Because my purpose is three-fold, to find yield, earnings growth, and dividend growth, it is easy to cut a few names off the list right away.

Martin Midstream Partners (MMLP) yields a stunning 24% but coverage is poor and it is not well-loved so not something I'm interested in. The next to go are Plains All American Pipeline (PAA) and Delek Logistics Partners (DKL) due to a negative outlook for earnings and/or revenue.

The remaining seven names each have something to offer. The others don't. The lowest yielding has the best history of distribution increases while the safest payouts have the highest yields. In all cases, EPS and revenue growth are expected which makes them candidates for dividend-growth investment for me.

  • BP Midstream Partners (BPMP)
  • Magellan Midstream Partners (MMP)
  • Enterprise Products Partners (EPD)
  • MPLX LP (MPLX)
  • Energy Transfer Partners (ET)
  • Noble Midstream Partners (NBLX)
  • Oasis Midstream Partners (OMP)

Own work; data sourced from Seeking Alpha

The Midstream Corporations, A Short List

I've already excluded Cheniere on the basis of distribution, there isn't one, and add to that TC Energy Corporation (TRP). I exclude TRP due to its negative outlook for 2020 earnings growth and low yield. This leaves four names with an average yield of 5.6%, two of which have been increasing their yield for at least ten years. The payout ratios are a little high but supported by solid revenue and earnings growth outlook.

  • ONEOK, Inc. (OKE)
  • The Williams Companies, Inc (WMB)
  • Kinder Morgan, Inc. (KMI)
  • Enbridge, Inc. (ENB)

Own work; data sourced from Seeking Alpha

The Refiners, What's Not To Like?

The refiners are by far my favorite group. With double-digit revenue and earnings growth on tap, extra-low payout ratios, and solid history of increases the only not to like is the yield. The 3.5% average yield of my short-list is more than twice the broad-market average but well below the midstream corporations and MLPs. All three names I started with remain on the list.

  • Phillips 66 (PSX)
  • Marathon Petroleum Company (MPC)
  • Valero Energy Corporation (VLO)

Own work; data sourced from Seeking Alpha

The VanEck Oil Refiners ETF (CRAK) whose top three holdings are PSX, MPC, and VLO, is trading up off of a low. CRAK is still facing significant resistance at the $30 level, but momentum is strong enough to expect a test of it. Once broken, investors can expect this one to advance 20%+ as it moves up to re-test last year's high. This ETF yields only 1.75% at today's prices, so a direct investment in one or more names is a better choice.

MLPs Versus MLP Funds

MLPs offer a high-yield growth opportunity but even so, (due to tax implications I am not qualified to talk about) they're not right for every portfolio. That's where MLP funds come into play. The number one MLP ETF, the Alerian MLP ETF (AMLP), includes 22 MLPs and covers the largest of the MLP universe. It is yielding about 8.75% at this time and trading near the bottom of its lifetime range.

The InfraCap MLP ETF (AMZA) covers nearly 100% of the MLP universe and provides leveraged exposure to the same. This ETF is yielding an eye-popping 20% that is aided by leveraged options strategies. Michael A. Gayed points out in his article InfraCap MLP ETF: The 20% Yield Is About To Get Cut Again that options trading has been costing the fund money, not enhancing returns. That said, the ETF is trading at its all-time low and looking extended. Regardless, it is likely to snap back along with the MLP market once the swing to growth is recognized by the market.

Brookfield And Exposure To Midstream Energy Infrastructure

Brookfield has several ways to gain exposure to midstream energy infrastructure including Brookfield Infrastructure Partners (BIP) and the Global Listed Infrastructure Income Fund (INF), but neither are pure plays. BIP owns and operates infrastructure businesses in 30 countries, including but not limited to 2,000 km of natural gas pipelines and 6.7 million retail utility connections (including natural gas). It yields about 4.0% at today's prices, comparable to both midstream corporations and midstream/refiners.

BIP has been riding a wave of positive earnings and sentiment all-year. Infrastructure has been a hot-ticket item as investors seek yield and the relative safety of real assets. The stock is sitting at its all-time high and looks like it could go higher. Technically speaking, I see a nice Bull Flag forming on the weekly charts that could take BIP up another 10% over the next few months.

The Global Listed Infrastructure Income Fund is a closed-end fund investing in equities of infrastructure companies. It has a heavy weighting of midstream and other energy infrastructure, fully seven of the top ten holdings are pipelines, and it yields a little over 7.25%. It has been described as a Leveraged Bet On Mid-Stream Pipelines and it is, with diversification electric utilities, technology infrastructure, toll roads, and other income-producing real assets.

The Global Listed Infrastructure Fund, too has been on a tear this year rising more than 40% off its December 2018 low. The near-term outlook is a little less robust than with Brookfield Infrastructure Partners, but the trend remains up. The next hurdle for it will be the two-year high near $14.00. If the $14.00 resistance gets broken, I would expect to see this fund advance to the $18 to $20 range.

To Sum It All Up

A well-respected leader in infrastructure investing alerted me to an opportunity in midstream energy infrastructure. Their thesis is the high-yielding sector pays a safe dividend supported by a shift to revenue and earnings growth. According to my research, this appears to be true, but there is so much more.

  • Businesses within the midstream sector regardless of business type and model are expecting both revenue and earnings growth.
  • The payout ratios and distribution coverage are still a little spotty company by company but generally acceptable and improving.
  • The yields are market-beating at least and, in many cases, almost too good to be true.
  • MLPs and MLP funds are trading at historically low levels offering deep value for dividend growth investors.
  • The refiners are poised for reversal, a reversal driven by robust earnings and revenue growth.
  • Total returns for many names in this group could easily top 15% to 20% in 2020.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.