“Be fearful when others are greedy and greedy when others are fearful” – Warren Buffett
There cannot be a more apt statement for a person contemplating investment in the energy sector. With the extreme volatility in crude prices, making predictions is becoming increasingly difficult. Just last week, the commodity fell to a six and half-year low of under $39 per barrel but soon rebounded to the mid-$40s.
Though not as volatile as oil, natural gas prices have also fared badly. The price of the commodity has remained below the $3 per Btu mark for several months now. Needless to say, the situation is worrisome.
This weakness has strongly affected the stock prices of almost all energy firms. Even energy sector premiers like Marathon Oil Corporation MRO, Noble Energy, Inc. NBL, Devon Energy Corporation DVN and ConocoPhillips COP declined over 30% year to date (YTD).
The soft pricing scenario hasn’t spared the master limited partnerships (MLPs) either. This asset class, which was considered less affected by commodity prices, has declined almost as much as the more sensitive upstream, drilling and services stocks. The Algerian index, a leading gauge of large- and mid-cap energy MLPs, plummeted about 20% YTD, while the S&P Oil & Gas Exploration & Production Select Industry Index plunged nearly 24% in the same time frame.
Commodity Price and MLPs
The aforesaid strong sell-off, however, is not justified for all MLPs. The influence of commodity prices differs from one MLP sub-sector to another. While upstream and gathering and processing MLPs have substantial exposure to commodity prices, midstream MLPs remain practically unperturbed by short-term price changes.
This is because a major portion of the revenues of transportation and storage MLPs comes from fee-based contracts. Also, sustained increase in oil and natural gas production is likely to boost infrastructural development. New pipelines and capacity expansions should further aid the business of these MLPs.
Moreover, the cash flow position of an MLP depends on the type of contracts (fee-based or margin sharing) it has. This makes midstream MLPs, with their long-term fee-based contracts, the best choice in the current market condition. This stable cash flow position is also the reason why several of these MLPs have increased distribution at a time when others are viewing payout cuts as a promising measure to reduce financial burden.
The Right Stock Picking Strategy
Since MLPs differ structurally from companies, stock picking based on common parameters such as PE or Price/Sales is not suitable here. For these businesses, metrics such as Distributable Cash Flow (DCF), Distribution Growth and Coverage Ratio are the key selection criteria. MLPs are valued according to their ability to generate, maintain and grow cash distributions.
An MLP that has not only paid and grown its distribution consistently but also has a distribution coverage ratio greater than one, would definitely be an optimal choice. The higher the ratio the better it is, as it ensures the safety of the distribution payment.
Each of the stocks mentioned below increased payouts recently and their coverage ratio is greater than one. Also, their favorable Zacks Rank #2 (Buy) is indicative of strong fundamentals. These stocks have, however, declined substantially this year due to the overall weakness in the sector. This current plunge in stock price, therefore, makes these better bargains at the moment.
3 Energy MLPs to Buy Now
TC PipeLines, LP TCP owns stakes in natural gas transportation assets that generate stable, recurring and low-risk earnings. The stock has consistently grown distributions over the past several years. TC Pipeline’s latest distribution of 89 cents marks 6% year-over-year growth.
Distribution Coverage (TTM): 1.28x
Distribution Yield: 6.79%
YTD Stock Price: -24%
The partnership also beat earnings estimates in three consecutive quarters and is expected to deliver year-over-year growth of 7.87%.
Dallas, TX-based EnLink Midstream, LLC ENLC is engaged in gathering, transmission, processing and marketing of oil, natural gas and natural gas liquids. The partnership recently paid quarterly cash distribution of 25 cents, which reflects year-over-year growth of about 14%.
Distribution Coverage (TTM): 1.51x
Distribution Yield: 4.38%
YTD Stock Price: -37%
The stock also beat estimates in three of the trailing four quarters and is expected to deliver 42.68% year over year growth.
Houston, TX-based Spectra Energy Partners, LP SEP is engaged in the transportation and storage of natural gas. The partnership increased distribution over the past several quarters. Its latest payout of 61 cents marks a year-over-year improvement of 8.39%.
Distribution Coverage (TTM): 1.32x
Distribution Yield: 4.93%
YTD Stock Price: -14%
The partnership surpassed estimates in each of the trailing four quarters with an average positive surprise of 37.96%. Moreover, an increase in current quarter and current year estimates suggest further bullishness ahead.
Look Beyond Current Weakness
Crude prices rebounding to the $70–$80 per barrel level is highly unlikely in the near-term with no catalysts in sight. However, the ever-increasing energy demand in the U.S. is leaving no dearth of growth or expansion opportunities. Moreover, as oil and gas prices remain volatile, partnerships with low commodity exposure and more fee-based cash flow options are better suited to benefit in the present market scenario.
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Click to get this free report DEVON ENERGY (DVN): Free Stock Analysis Report CONOCOPHILLIPS (COP): Free Stock Analysis Report NOBLE ENERGY (NBL): Free Stock Analysis Report MARATHON OIL CP (MRO): Free Stock Analysis Report SPECTRA EGY PTR (SEP): Free Stock Analysis Report TC PIPELINES (TCP): Free Stock Analysis Report ENLINK MIDS LLC (ENLC): Free Stock Analysis Report To read this article on Zacks.com click here. Zacks Investment Research