For investors looking for income, there is perhaps no better industry to look at than pipelines. Companies in the sector are in their best financial shape in years, while their valuations are trading well below pre-pandemic levels.
In fact, the sector generally traded at around a 13.7 times average enterprise value (EV)-to-EBITDA multiple between 2011 and 2016, while today most midstream stocks trade at under a 10 times multiple. EV/EBITDA tends to be the most used metric to value midstream companies, as it takes into consideration their debt positions and takes out non-cash expenses.
Let's look a three no-brainer stocks to buy in the sector that will give you both a stream of distribution income as well as strong price appreciation potential.
Western Midstream
After just announcing a whopping 52% increase to its distribution, Western Midstream(NYSE: WES) sports one of the highest yields in the midstream industry. The company increased its quarterly distribution to $0.875 per unit from $0.575 a quarter earlier. Based on its new payout, the stock is now yielding 9.3%.
Better yet, the company recently reported record first-quarter adjusted EBITDA of $608.9 million, up 22% year over year. Western saw record natural gas throughput across its systems. The company has a strong presence in the Delaware Permian, the most prolific oil basin in the U.S. However, it is also seeing a resurgence in the Denver-Julesburg (DJ) Basin in Colorado, with well counts approximately doubling from a year ago.
The company ended the first quarter with 3.3 times leverage (net debt/adjusted EBITDA) and is on track to get it to 3 times by the end of the year. At that point, Western has said it is prepared to pay out enhanced distributions on top of its already robust base distribution. Given the company's strong balance sheet and distribution coverage ratio, 2025 should see the company pay out distributions above its already robust quarterly $0.875 payout.
Trading at only a 9 times forward EV/EBITDA multiple, Western stock is a no-brainer for income-oriented investors.
WES EV to EBITDA (Forward) data by YCharts
Enterprise Products Partners
One of the best-run midstream operators, Enterprise Product Partners(NYSE: EPD) has been a model of consistency over the past two decades. Through various economic and energy cycles, it has increased its distribution for 25 straight years.
The company is in strong financial shape, carrying modest leverage for the industry of just 3 times. Meanwhile, it is currently paying out a $0.515 per-unit quarterly distribution, which was a 5.1% increase compared to a year ago. That's good for a yield of 7.2%.
Image source: Getty Images.
Even more exciting for investors is that Enterprise is beginning to ramp up growth after throttling it down coming out of the pandemic. After reducing its growth capital expenditures (capex) to only $1.4 billion in 2022, the company boosted it to $3.5 billion in 2023 and it plans to spend around $3.5 billion this year as well. Projects take time to be built and then ramp up, so the benefits of this spending should start to materialize in the coming years.
Meanwhile, after a five-year wait, Enterprise just received an important license that will allow it to move forward with its proposed Sea Port Oil Terminal (SPOT) project. SPOT could be a game-changing project that would make Enterprise a big player in crude exports.
With this master limited partnership (MLP) trading at only 9.3 times on a forward EV/EBITDA basis, now is a great time to invest in the stock.
EPD EV to EBITDA (Forward) data by YCharts
Energy Transfer
Energy Transfer(NYSE: ET) is the cheapest of the three midstream stocks, although arguably it has some of the best assets. Its large integrated system that has been created through growth projects and acquisitions touches on nearly all aspects of midstream activities. This has given the company a tremendous amount of scale. In simple terms, the company's large interconnected system allows it to find the best prices to move product. This can be through storing hydrocarbons (crude, natural gas, and natural gas liquids) for use at more attractive times, by upgrading the products to something more valuable, or shipping them to more attractively priced markets.
Energy Transfer is building a midstream empire and makes no qualms about it. However, that did cause the company to get over its skis back in 2020, when it had to cut its distribution in half to help improve its balance sheet.
However, the company has not only returned its distribution to prior levels, it is now higher than it was before the cut. Meanwhile, its balance sheet, while not as strong and Enterprise's or Western's, has been repaired, and the company is smartly generating free cash flow in excess of its distributions. This is a strong sign that it won't run into the trouble it did back in 2020 when it overextended itself in its efforts to grow.
Trading at just 7.4 times forward EV/EBITDA, the new and improved Energy Transfer is one of the biggest bargains in the space right now. The company is solidly growing and increasing its distribution, but doing so in a more responsible way while continuing to reduce leverage. That makes the stock an attractive buy.
ET EV to EBITDA (Forward) data by YCharts
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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 a disclosure policy.
