For over 100 years, trains pulling loads of coal destined for energy production have powered much of the U.S. But times are changing and natural gas appears destined to become the fuel of choice. As a result of this shift, the midstream sector, which transports gas and liquids in pipelines, could become the next great investment for generations to come. Here are three reasons why this sector is a top pick for long-term investors followed by three names you may want to add to your portfolio.
Safety
I often compare midstream assets to railroads. They both collect tolls on owned assets that require little maintenance. Competition is limited due to high barriers of entry, which include the capital-intensive nature of construction, regulatory hurdles that span multiple jurisdictions, and difficulty obtaining rights of way. Midstream assets are fairly insulated, even during harsh economic times, due to the inelastic nature of energy demand.
Growth
Of the 300,000 MW of electricity generated by coal plants, 60 MW is expected to go offline by 2016 according to the EIA.
Source: EIA
Making up the difference, according to EIA projections through 2040, will be natural gas.
Source: EIA
With the economy becoming more dependent on natural gas for electricity generation, it will also become more dependent on pipelines that transport this fuel. As mentioned before, there are high barriers to entry in the MLP space, putting existing owners in the highly enviable position of benefiting from this steady growth.
Yield
While there are many successful long-term investment strategies, one of my personal favorites is finding growth stocks that pay a healthy return. Couple that with a reinvestment plan and watch the power of compounding boost your returns. With that said, midstream companies are some of the highest yielding stocks in the energy sector, if not the entire market.
Kinder Morgan Pipeline Partners (NYSE: KMP) is my top pick in the sector. It owns and operates the largest network of pipelines in the U.S. Its assets include pipelines from the Marcellus shale formation, the fastest growing formation in the U.S. In 2012 it also purchased key pipelines in the Northeast that supply major urban areas in New England, among them Boston, which has been hit exceptionally hard the last couple years with harsh winter weather.
A 7.25% yield is among the highest in the industry. The best part is consistent increases in distributions. Kinder Morgan Pipeline Partners has a 5-year distribution growth rate of 39%. Compare that to the industry average of 1.17% and it's easy to see why this stock is a favorite among yield-oriented investors.
Look for this growth to continue as analysts are predicting a 12% increase in earnings for 2014 over 2013.
Williams Partners (NYSE: WPZ) has been on a roll lately. Over the last five years the stock is up over 440%. Normally with such hyper growth you'd see a small yield failing to keep pace with stock appreciation. Not the case here as Williams currently yields 7.20%.
Impressive capital spending with a 5-year growth rate of 189% geared toward expansion and acquisitions look to fuel further growth. Analysts are looking for a 45% increase in FY 2014 earnings compared to 2013.
Finally, it is doing all this with its debt under control -- its long-term debt/equity ratio is at 0.89.
El Paso Pipeline Partners (EPB) suffered a significant drop at the end of 2013 following some poor quarterly numbers. But this drop could be exactly what long-term investors are looking for provided it was a one time event. As a result of this pullback the yield is at an industry high of 8.60%. Now plug in a 5-year distribution growth rate of 30% and there could be real potential here.
However, revenue and earnings projections look to remain flat over the coming year according to analysts. But improving ROE, which is among the highest in the industry, coupled with a high gross profit margin should provide some stability and even gains going forward. Therefore, the only concern for this stock would be the high LT debt/equity of 2.15.
Final thoughts
MLP's provide a unique investment opportunity these days. They offer great yields and the potential for growth. Competition is held at bay through significant barriers to entry. Finally, they transport fuel that is vital to the economy contributing to the inelastic nature of its business. If you're looking for safe, reliable, and growing long-term investment, look no further than the MLP space.
