Oil prices have cooled off considerably over the past year. That has put downward pressure on most energy stocks, especially on companies that produce oil.
However, not all energy stocks have fallen along with crude prices. Midstream giants Energy Transfer(NYSE: ET), Plains All American Pipeline(NASDAQ: PAA), and MPLX(NYSE: MPLX) have surged over the past year. Here's what fueled that rally and why it should continue.
Room to grow
Units of Plains All American Pipeline have surged almost 35% over the past year. A big driver of that rally is the pipeline company's success in deleveraging its balance sheet.
Last fall, Plains All American Pipeline unveiled that it had achieved a leverage ratio below the midpoint of its 3.75-4.25 target range. That enhanced its financial flexibility, allowing the pipeline company to return more cash to investors. It revealed a new multi-year capital allocation framework.
The centerpiece of that plan is a growing distribution. Plains All American Pipeline boosted its annualized payout rate from $0.87 per unit to $1.07 per unit (23%), pushing its dividend yield up to 8.1%. In addition, the company plans to increase its distribution by $0.15 per unit each year until it reaches a distribution coverage ratio of about 160% of its cash flow. The company expects coverage to be around 215% this year, suggesting it has plenty of room to grow. That rising payout should give units the fuel to continue moving higher.
Still extremely cheap
Units of Energy Transfer have rallied nearly 25% over the past year. A big factor fueling that rebound is the improvement in its balance sheet. That has allowed the master limited partnership (MLP) to significantly increase its distribution.
The midstream company slashed its distribution in 2020 to retain additional cash for debt reduction. That strategy worked as planned. Energy Transfer has paid down debt over the past couple of years, enabling it to get its leverage ratio down within its target range of 4.0-4.5. As leverage came down, the MLP increased its distribution. It brought the payout back to its pre-pandemic level earlier this year. Meanwhile, Energy Transfer recently set a new goal of growing its payout by 3% to 5% per year.
Even with the big rally in its unit price, Energy Transfer's distribution yields an eye-popping 9.8%. That's because the MLP still trades at a dirt cheap valuation. The midstream company expects to produce $13.1 billion to $13.5 billion of adjusted EBITDA this year. With a current enterprise value (EV) of $94.2 billion, Energy Transfer trades at a bottom-of-the-barrel valuation of around seven times EV/EBITDA. That leaves plenty of room to continue surging.
Cheap, with visible growth ahead
Units of MPLX have risen more than 15% over the past year. Even with that rally, the MLP currently yields an attractive 9.3%.
Like Energy Transfer, MPLX trades at a low valuation. The MLP has produced $5.9 billion of adjusted EBITDA over the last 12 months. With a current EV of $53.8 billion, it trades at a relatively low valuation at around nine times EV/EBITDA.
Earnings should continue rising. The midstream giant is advancing several high-return expansion projects across its three core operating areas that should come online through next year. These projects will grow its cash flow, giving the MLP more fuel to increase its distribution. It gave investors a 10% raise last year, continuing the steady growth in its payout since its formation more than a decade ago.
With a cheap price and more earnings and distribution growth ahead, MPLX's unit price should keep rising.
More room to run
MLPs Energy Transfer, Plains All American Pipeline, and MPLX have rallied sharply over the past year. A big driver is the overall improvements in the pipeline industry as companies like Energy Transfer and Plains completed their deleveraging strategies. That's giving them more money to return to shareholders, allowing them to pump up their already high-yielding distributions. With valuations still relatively low across the sector and more distribution growth ahead, these MLPs have the fuel to surge even higher. They offer investors ample income and upside potential, making them attractive buys right now.
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Matthew DiLallo has positions in Energy Transfer. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
