Oil & Gas Refining & Marketing MLP Industry: An Investment Opportunity

Master limited partnerships (or MLPs) differ from regular stocks in that interests in them are referred to as units and unitholders (not shareholders) are partners in the business. Importantly, these hybrid entities bring together the tax benefits of a limited partnership with the liquidity of publicly traded securities. The assets that these partnerships own typically are oil and natural gas pipelines and storage facilities.

The Zacks Oil and Gas - Refining & Marketing MLP industry is a sub-sector of this business model. These firms operate refined products' terminals, storage facilities and transportation services. They are involved in selling refined products (including heating oil, gasoline, residual oil, etc.) and a plethora of non-energy materials (like asphalt, road salt, clay and gypsum).

Let’s take a look at the industry’s three major themes:

• Most MLPs derive their revenues based on the amount of fuel transported and are relatively insulated from oil and refined product price fluctuations. The defensive, fee-based business model not only provides cash flow stability to the refining and marketing MLPs but also make long-term distribution growth more predictable. Since the revenues they earn are volume-driven and often under long-term contracts, the pipeline operators are likely to enjoy stable demand for their services even if the U.S. economy slows.

• The fortunes of downstream refining and marketing MLPs are tied to the underlying developments in their business. Therefore, with domestic supplies of gasoline – the most widely used petroleum product – currently above the five-year average range, the industry operators should brace themselves for continued weakness in margins. The fuel's crashing profitability on the back of high inventories will also hurt earnings and the cash flows at a time of the year that typically sees heightened demand for gasoline with the start of the U.S. summer driving season. Further, United States’ planned tariffs on Mexico could make oil imports (Maya crude, Mexico's primary grade of oil) more expensive for the production of petroleum products. The implication would be lower profit margins for refiners, possibly trickling down to the transportation infrastructure providers.  

• The sentiment among pipeline investors remains cautious following the FERC policy revision (per orders issued on July 2018) that signaled significant future changes on how the pipeline partnerships will go about treating income taxes in their books of accounts. Partnerships charging cost-based rates for interstate transportation service would have to lower customer tariffs to move oil, gas and refined products around the country by the amount of their income tax allowances — substantial in certain cases. A reduction in cost recovery would likely cut into their cash flows. With the new rule expected to be adopted only by 2020, the issue may remain a thorn in the flesh for the foreseeable future.

Zacks Industry Rank Indicates Improving Outlook

The Zacks Oil and Gas - Refining & Marketing MLP is a 14-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #99, which places it in the top 39% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bearish near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s earnings growth potential. While the industry’s earnings estimates for 2019 have increased 5.4% since Feb 28, 2019, the same for 2020 have gone up 13.7% over the same period.

Before we present a few stocks that you may want to consider, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Outperforms Sector but Lags S&P 500

The Zacks Oil and Gas - Refining & Marketing MLP industry has outperformed the broader Zacks Oil - Energy Sector over the past year but has lagged the Zacks S&P 500 composite over the same period.

The industry has declined 12.9% in the past year compared with the S&P 500’s gain of 2.5% and broader sector’s decrease of 19.1%.

One-Year Price Performance

Industry’s Current Valuation 

Since midstream-focused oil and gas partnerships use fixed rate debt for the majority of their borrowings, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of noncash expenses.

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, the industry is currently trading at 13.62X, higher than the S&P 500’s 10.48X. It is also significantly above the sector’s trailing-12-month EV/EBITDA of 4.71X.