Although the midstream energy sector is less vulnerable to oil and gas prices, the outlook for the Zacks Oil and Gas - Pipeline MLP industry remains uncertain. Conservatism in capital expenditures by upstream companies could lower the utilization of midstream assets. Additionally, a significant debt burden continues to hinder the ability of midstream energy companies to fund new projects and weather economic downturns.

Despite the challenges, pipeline players are in a stronger position than upstream and downstream firms, as they benefit from steady, fee-based income through long-term contracts with shippers. Leading companies in the sector include Enterprise Products Partners LP EPD, Energy Transfer LP ET and Plains All American Pipeline LP PAA.

About the Industry

The Zacks Oil and Gas - Pipeline MLP industry comprises master limited partnerships (or MLPs) that primarily transport oil, natural gas, refined petroleum products and natural gas liquids (NGL) to consumers in North America. Apart from transporting the commodities, the partnerships have huge capacities to store oil, natural gas and petrochemical products.  The partnerships thus provide midstream services to producers and consumers of the commodities. The firms generate stable fee-based revenues from all these transportation and storage assets. The services provided by the MLPs entail the gathering and processing of commodities. The integrated midstream energy players also generate cashflows from ownership interests in fractionators and condensate distillation facilities.

What's Shaping the Future of Oil & Gas - Production & Pipelines Industry?

High Debt Load: The industry is inherently capital-intensive, as evident in the debt-to-capitalization ratio of 55%, where borrowing is a common practice to finance large infrastructure projects. However, elevated leverage can constrain financial flexibility, hindering midstream energy companies' capacity to invest in new developments, navigate economic downturns, or address unforeseen costs.

Shift to Renewables: Energy majors will increasingly face challenges in providing sustainable energy to the world while reducing greenhouse gas emissions. Thus, to address the issues of climate change, there will be a gradual shift from fossil fuel to renewable energy. This will lower the demand for the partnerships’ pipeline and storage networks for oil and natural gas.

Explorers’ Conservative Capital Spending: Oil and gas exploration and production companies are facing heightened pressure from investors to focus on stockholders’ returns rather than production. This is hindering the production growth of commodities, thereby denting the demand for pipeline and storage assets.

Story Continues

Zacks Industry Rank Indicates Weak Prospects

The Zacks Oil and Gas - Pipeline MLP industry is a six-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #162, which places it in the bottom 34% 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 dull near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries forms an unfavorable earnings outlook for the constituent stocks in aggregate. Before we present a few stocks that you may want to consider, let’s look at the industry’s recent stock market performance and its valuation picture.

Industry Outperforms Sector & S&P 500

The Zacks Oil and Gas - Pipeline MLP industry has outperformed the broader Zacks Oil - Energy sector and the Zacks S&P 500 Composite over the past year. The industry has rallied 17.5% in the past year against a decline of 4.1% of the broader sector and an improvement of 12.4% of the S&P 500.

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 stocks, 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), the industry is currently trading at 11.47X, lower than the S&P 500’s 16.51X. It is, however, significantly above the sector’s trailing 12-month EV/EBITDA of 4.56X.

Over the past five years, the industry has traded as high as 12.88X and as low as 7.48X, with a median of 9.95X.

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

3 Oil & Gas Pipeline MLPs to Gain

Enterprise Products, a top-tier North American midstream service provider, boasts a vast and diversified asset portfolio. This includes more than 50,000 miles of pipelines and a storage capacity of 300 million barrels. These assets are utilized by shippers on long-term contracts to transport and store natural gas liquids, crude oil, refined products and petrochemicals. The partnership, carrying a Zacks Rank #3 (Hold), also has 14 billion cubic feet of natural gas storage capacity, securing stable fee-based revenues.

Additionally, EPD is set to generate additional fee-based earnings with $7.6 billion worth of major capital projects either currently in service or under construction. These project backlogs will not only ensure stable cashflows but will also generate handsome unitholder returns.

Price and Consensus: EPD

Energy Transfer has a stable business model with its huge pipeline network of natural gas, oil and refined petroleum products across 125,000 miles. The partnership has midstream assets in all the key basins in the United States, generating stable fee-based revenues.

Energy Transfer, carrying a Zacks Rank #2 (Buy), has offered a higher dividend yield than the composite stocks belonging to the industry over the past year. For this year, the partnership is likely to see earnings growth of 12.5%.

Price and Consensus: ET

Plains All American Pipeline also enjoys stable fee-based revenues, banking on its oil and natural gas pipeline network and storage assets. In 2025, the #3 Ranked stock is likely to see top-line growth of 5.1%.  You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: PAA

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Enterprise Products Partners L.P. (EPD):Free Stock Analysis Report

Plains All American Pipeline, L.P. (PAA):Free Stock Analysis Report

Energy Transfer LP (ET):Free Stock Analysis Report

This article originally published on Zacks Investment Research (zacks.com).

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