After several leaner years, energy midstream companies have reached an inflection point. Many in the sector will start producing significant excess free cash flow after funding their dividends and expansion programs. That would give them even more money to return to investors via higher dividends and share repurchases. Those higher cash returns could fuel monster total returns.

Here's a look at some of the pipeline stocks poised to produce the most excess cash in the coming years.  

Reaching an inflection point

Citi analyst Spiro Dounis recently published a new report on the U.S. midstream sector. The analyst wrote that the industry has "entered a new period of elevated capital returns" as free cash flow should surge. 

The analyst estimates that midstream companies will generate 15% of their market caps in free cash flow over the next five years even after paying their dividends (which yield 7% on average). That adds up to $50 billion in excess free cash for a sector that didn't produce any over the last five years. 

The analyst noted three factors fueling this forecast: 

  • Slowing shale growth: Oil and gas companies have shifted their capital allocation strategy from growing at all costs to increasing their free cash flow. As a result, midstream companies don't need to invest as much capital to support the industry's expansion.
  • Deleveraging complete: Midstream companies have spent the past three years paying down debt and achieved their target leverage ratios. That will free up additional cash to return to investors.
  • Efficient expansions: The midstream industry has largely built out all the major new infrastructure needed to support future production growth, leaving companies free to focus on expanding existing infrastructure, which is much more capital efficient than building new projects.

Becoming gushing cash machines

Dounis identified several midstream companies poised to produce the most excess cash flow over the next five years. EnLink Midstream (ENLC 0.80%) is among the leaders at more than 35% of its market cap. The midstream company has come a long way in recent years. It was one of many in the sector to slash its dividend during the early days of the pandemic to preserve cash. EnLink cut its payout by 50% in 2020, saving $185 million to preserve liquidity and strengthen its balance sheet. 

Fast-forward a few years, and EnLink has a much stronger financial position. Its leverage ratio has fallen to 3.4, leading one credit rating agency to upgrade its bond rating to investment grade. With its balance sheet on stronger ground, EnLink has been able to start returning more of its excess free cash to investors. Earlier this year, the company increased its distribution by 11%, pushing its yield up to 5.2%. Meanwhile, EnLink repurchased $200 million of its units last year and plans to buy back another $200 million in 2023. Given its strong free cash flow, the company will likely continue returning more cash to investors in the coming years.

The Citi analyst highlighted Western Midstream (WES -0.03%), Energy Transfer (ET 0.12%), and Plains All American Pipeline (PAA -1.11%) as companies that should generate more than 25% of their market caps in excess free cash over the next several years. That should give them more money to return to investors.

Energy Transfer recently achieved its targeted leverage ratio of 4.0 to 4.5. That enabled the midstream giant to return its distribution to its pre-pandemic peak. The company has now set a new target of growing its distribution (which currently yields an attractive 9.7%) by 3% to 5% per year. 

Western Midstream is also piping more cash back into its investors. The company pays a quarterly base distribution ($0.50 per unit), which gives it a compelling 7.5% yield. In addition, Western Midstream returns more cash via its enhanced annual distribution and repurchases. Western recently paid an additional $0.356 per unit enhanced distribution based on its strong 2022 results. Meanwhile, it has repurchased nearly $500 million of its units as part of a $1.25 billion repurchase program that runs through the end of next year.

Plains All American Pipeline achieved its leverage target of 4.0 last year. That allowed it to unveil a new multi-year capital allocation framework. Plains All American boosted its annual distribution by $0.20 per unit (23%) to $1.07 per unit (giving it a nearly 8% yield). Meanwhile, the company plans to increase its payout by $0.15 per unit each year until its coverage ratio falls to 160% (it should be 215% this year). The company also plans to repurchase units opportunistically. 

High total return potential

EnLink Midstream, Western Midstream, Energy Transfer, and Plains All American Pipeline are among the many midstream companies that have reached a new phase. They have largely built out their midstream platforms and deleveraged their balance sheets. They will generate a lot more excess cash in the future.

That will give them more money to return to investors through higher distributions and repurchase programs. Add in their already high-yielding payouts, and these midstream companies could produce monster total returns in the coming years. That makes them compelling investment opportunities for those seeking income with upside potential.