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3 Beaten-Up Energy Stocks: Are They Bargains?

By Matthew DiLallo – Apr 18, 2018 at 9:18AM

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The publicly traded midstream subsidiaries of these well-known energy stocks have taken it on the chin this year.

Most investors have probably heard of energy giants Royal Dutch Shell (RDS.A) (RDS.B), Dominion Energy (D -2.74%), and TransCanada (TRP -2.28%). Fewer, however, are likely familiar with their publicly traded master limited partnerships (MLPs): Shell Midstream Partners (SHLX -0.25%), Dominion Energy Midstream Partners (NYSE: DM), and TC Pipelines (TCP). That might be a good thing, as the market has beaten up the latter trio this year, sending their valuations south.

However, while all three are now much cheaper, that doesn't necessarily make each one a bargain worth buying. 

Man in a suit looking at an down arrow going through a floor.

It has been a rough year for this trio of MLPs. Image source: Getty Images.

Selling off for no reason

Shell Midstream Partners has lost a quarter of its value this year, which has pushed its yield up to nearly 6%. Much of that sell-off stems from a rule change that impacted the ability of MLPs to collect taxes along with their service rates on some pipelines. However, Shell Midstream made it clear that this policy revision will have no material impact on its earnings since it gets the bulk of its revenue from sources with no exposure to this policy.

As a result, Shell Midstream believes it will have no problem paying its distribution, which it still expects to increase another 20% this year and at a mid-teens rate for 2019. The company has already raised the capital it needs to fund this growth, which it expects will come from acquiring another $1 billion to $1.4 billion in assets from Shell later this year. With that income growth seemingly all locked up, the 25% valuation discount makes Shell Midstream look like a bargain right now.

A cause for concern

TC Pipelines has fared even worse, losing more than a third of its value in 2018, which has pushed its yield up close to 12%. When a yield reaches into the double digits, that's usually a warning sign that the market doesn't believe the company can maintain its current payout rate.

TransCanada's MLP generated more than enough cash flow to fund its high-yield distribution last year, covering it by a healthy 1.1 times. That margin of safety, however, could vanish as a result of the rule change. While TC Pipelines stated that it's still evaluating the potential impact, it does get 55% of its revenue from assets subject to the policy, so it could lose a substantial slice of its cash flow going forward.

Under a worst-case scenario, TC Pipelines might need to reduce its payout significantly, which could cause it to lose even more value. It's also possible that TransCanada could take advantage of the situation and buy out TC Pipeline for a cheap price. Since the rule only impacts MLPs, it could reinstate the fees after buying TC Pipelines and pocket the value difference. This uncertain future makes it hard to know if TC Pipelines is a bargain or a possible value trap.

Pair of scissors cutting a $100 bill

A reduction in cash flow from the rule change could send these energy stocks even lower. Image source: Getty Images.

Needs more clarity

Dominion Energy Midstream has been absolutely hammered this year, shedding nearly 50% of its value, which has driven its yield up to 8.1%. The MLP rule change is the main thing weighing on its price.

Its parent, Dominion Energy, believes that the policy revision will take years to implement and won't have much impact on revenue. As a result, the company doesn't anticipate any cash flow reductions at Dominion Midstream Partners through 2020. However, the companies are re-evaluating their growth strategy, which would have seen Dominion Energy Midstream increase its payout at a 22% compound annual rate through 2020 fueled by a steady stream of dropdown transactions from its parent. Among the options Dominion is considering is dropping down its interest in a natural gas export facility instead of additional pipelines to get around the rule change. It's also possible that Dominion could opt to buy out its MLP rather than deal with this hassle. Until there's clarity on the impact this change will have on Dominion Energy Midstream, it's tough to tell if it's a bargain or not.

Stick with certainty

While the market beat up this trio of MLPs this year, only Shell Midstream looks like a bargain to consider buying because the recent rule change won't have any impact on cash flow or its growth plan. Dominion Midstream and TC Pipelines, on the other hand, could continue declining until there's more clarity on their futures. While neither partnership nor their parent companies seem worried, it's better to be safe than fall into what could be value traps.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends Dominion Energy, Inc. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Shell Midstream Partners, L.P. Stock Quote
Shell Midstream Partners, L.P.
$15.81 (-0.25%) $0.04
Royal Dutch Shell plc Stock Quote
Royal Dutch Shell plc
TC Energy Corporation Stock Quote
TC Energy Corporation
$40.29 (-2.28%) $0.94
Royal Dutch Shell plc Stock Quote
Royal Dutch Shell plc
Dominion Resources, Inc. Stock Quote
Dominion Resources, Inc.
$69.11 (-2.74%) $-1.95
TC PipeLines, LP Stock Quote
TC PipeLines, LP

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