The midstream sector (AMLP) has been my favorite overall sector since the energy price crash in 2020, and I loaded up on the sector as a result. Since our portfolio launched in December 2020, this approach has served us very well, as the sector has delivered exceptional total returns over that period:
I have owned quite a few midstream stocks over that period of time, including Energy Transfer (ET), Plains All American Pipeline (PAA)(PAGP), Western Midstream (WES), Enterprise Products Partners (EPD), MPLX (MPLX), TC Energy (TRP), Magellan Midstream Partners (which has since been acquired by ONEOK (OKE)), Kinder Morgan (KMI), and several others. In aggregate, these holdings have delivered even stronger total returns than the broader midstream sector.
In today's article, I am going to share the four midstream stocks that I would own today if I had to own only four:
#1. Enterprise Products Partners
My case for favoring EPD is pretty easy to make. Its business model is well-diversified and fully integrated. Moreover, it has a phenomenal track record of generating double-digit returns on invested capital even during periods where energy prices are crashing. As a result, it is not surprising to see that it has delivered market-crushing total returns over the long term:
In addition, it has the sector's best credit rating (A-) with a remarkably low leverage ratio (~3.0x), substantial liquidity, and a weighted average term to maturity of nearly two decades on its debt.
It also has one of the sector's most impressive distribution growth track records, spanning a quarter century of yearly increases that only Enbridge (ENB) matches or exceeds elsewhere in the midstream sector. Such unitholder-friendly capital allocation is not surprising given that insiders own about one-third of EPD's common units. On top of all of these other strengths, EPD's valuation remains quite compelling as it trades at a discount to its historical average, offers a 7.1% distribution yield that is covered ~1.7x by distributable cash flow and has been growing at a ~5% CAGR in recent years, and has a substantial growth profile with $6.8 billion of approved projects under construction. As a result, it offers one of the most compelling risk-reward profiles in the midstream sector, especially for risk-averse investors. You can read more details on my bullish thesis for EPD here.
#2. TC Energy
TRP is another very attractive midstream company that has the distinction of owning a large number of high-quality, mission-critical utility-like regulated assets, giving them greater long-term cash flow security than the contracted-heavy asset portfolios of many other midstream companies. Its portfolio strength was on full display last quarter as it generated comparable EBITDA growth of 16% on a year-over-year basis (though this was partly due to a one-time bonus payment due to the Coastal Gaslink project progressing on time and within budget).
The company also has a solid investment-grade balance sheet which it is making significant progress towards strengthening further as it sells off assets in order to deleverage its balance sheet while still growing its cash flow per share at a steady clip by investing in its substantial and very attractive growth project pipeline.
Like EPD, TRP has an impressive track record of growing its dividend per share consistently over time, recently hiking its dividend by 3.2% to mark 24 consecutive years of dividend growth.
Last, but not least, its well-covered dividend yield of 6.9% combines with its mid-single digit expected per share DCF CAGR to present a relatively low-risk path to double-digit annualized total returns. Moreover, its stock could see further upside if its valuation multiples were to expand back to being in line with its historical valuation averages. Moreover, the company plans to complete a spin-off of its liquids pipelines business in the near future, which could potentially unlock further value for shareholders. You can read more details on my bullish thesis for TRP here.
#3. Kinder Morgan
KMI is a stock that I only recently bought as it has traditionally traded at a premium to peers that I felt was not quite fully warranted. Yes, its natural gas pipeline portfolio is arguably the best in the industry and has attractive long-term prospects. However, the company's per-share DCF and dividend growth have been relatively weak in recent years.
I suspect that is about to change, though, which - when combined with the company's more attractive valuation - is why I am now more bullish on the stock. Between its significantly strengthened/de-risked balance sheet, impressive and low-risk collection of assets, EV/EBITDA multiple that looks quite attractive relative to its fellow C-Corp peers and even several MLPs, its significant dry powder to drive per-share growth via buybacks and accretive acquisitions (such as it recently completed for the South Texas Pipelines from NextEra Energy Partners (NEP)(NEE)), and its impressive, high-returning growth investment pipeline, KMI appears poised to deliver very attractive risk-adjusted returns moving forward.
You can read more details on my bullish thesis for KMI here.
#4. Energy Transfer
While ET's unit price has exploded since I added it to my portfolio in December 2020, it remains an attractive high-yield investment today:
While I no longer expect it to deliver market-crushing returns moving forward, I still think outperformance is possible, given its 8% yield and 3-5% expected distribution CAGR. Moreover, its yield is quite safe given its recently fortified investment-grade balance sheet (that is only getting safer as management takes out many of the preferreds), near 2x distributable cash flow coverage, and solid long-term growth prospects. Moreover, its EV/EBITDA multiple of ~8x puts it at a clear discount to peers like MPLX and EPD. While its track record is not as strong as these peers, it is definitely not overvalued at the moment in our view and may warrant a higher valuation multiple in the future if it can continue to exercise discipline and prioritize distribution growth over asset growth at all costs.
You can read more details on my bullish thesis for ET here.
Taxation Comments
Note that EPD and ET issue a K-1 tax form, which makes them potentially unsuitable for holding in a retirement account. TRP, meanwhile, is a Canadian Corporation, so it has a portion of its dividend withheld for foreign taxes unless held in a U.S. retirement account (due to a tax treaty between the U.S. and Canada). Moreover, its dividends are declared in Canadian Dollars, so there is some currency-related volatility in its dividend payments for U.S. Dollar-denominated investing accounts. As always, be sure to do your own tax due diligence as this is not tax advice.
Investor Takeaway
Midstream infrastructure stocks have been very kind to me in recent years, providing me with a lucrative stream of income that continues to grow alongside market-crushing total returns. I expect more good things to come from this sector and therefore remain long the four midstreams listed in this article, though I do not expect such generous rates of return to persist moving forward.
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