Midstream Earnings Delight Once Again
Energy Transfer (ET) is the name most widely owned among those financial advisors we know with direct investments in the sector. It is perennially cheap, and it’s a frequent topic of conversation. It’s also a significant position of ours, so it was especially pleasing to see their strong second quarter earnings.
As well as beating expectations across all business segments, ET raised full year EBITDA guidance from a midpoint of $18.7BN to $19BN. Power demand is an important driver of new projects. Much of their gas backlog is in energy-friendly Texas, where environmental extremists don’t have much luck in slowing projects through lawsuits.
ET raised their distribution by 3%, to a 6.7% yield where it’s more than 2X covered by Distributable Cash Flow (DCF). Even with a 24% one year total return, this still looks cheap to us although the MLP discount because of the K1 means it’s destined to remain cheap compared to its c-corp peers.
Targa Resources (TRGP) stock has the best one-year performance at +64%. The company’s vertical integration is routinely cited by analysts as their great strength. JPMorgan likes TRGP’s, “fully integrated well-to-dock Permian NGL value chain” as a differentiated growth story for years to come. Management teams often refer to “multiple opportunities to touch the molecule”, meaning they can charge a fee at each stage.
Natural Gas Liquids (NGLs) get less attention than oil and gas, but US exports of propane and butane (together Liquefied Petroleum Gas or LPG) are growing strongly with propane exports above 2 Million Barrels per Day (MMB/D), an almost doubling over the past five years. TRGP has exploited this. Over half our propane exports head to Asia with Japan, China, South Korea and India all important buyers.
TRGP is guiding to EBITDA growth of 17% this year although Thursday’s earnings report suggested they could do slightly better. JPMorgan is modeling 20% annual growth in per share DCF (applying an MLP valuation metric to a corporation for easy comparisons).
The +29% one-year return delivered by Enterprise Products Partners (EPD), while not as good as TRGP reflects the reliability of their underlying business. EPD has long been the dominant exporter of US NGLs, and growing demand has boosted their business as well. EPD has a similar MLP valuation discount to ET and currently yields 6% with 1.7X coverage.
What continues to surprise us is the relative underperformance of the natural gas exporters. Propane exporters like EPD and TRGP have excited investors more than exporters of methane. Consequently, Cheniere (LNG), Venture Global (VG) and NextDecade (NEXT) all lagged the sector’s benchmark, the American Energy Infrastructure Index (AEITR), over the past year.
Once war with Iran broke out, they closed the gap somewhat, but we continue to think the market is underestimating their long-term advantage. Qatar’s reputation as a reliable provider of liquefied natural gas has been permanently damaged by its inability to resume regular shipments for over five months.
All three stocks react to daily swings in the Asian and European benchmarks. While VG is able to profit from the arbitrage against US prices, LNG has very limited spot capacity and NEXT isn’t even exporting yet. They all stand to benefit from Qatar’s facilities being permanently at risk of attack by Iran. Qatar’s existing counterparties must wish they had signed up with exporters unthreatened by Iran, like the US.
VG and NEXT are both still down over the past year and LNG is only +11%, even though the market environment for all of them has improved.
Cheniere’s 2Q earnings report on Thursday beat expectations, boosted EBITDA guidance and projected higher volumes. It’s hard to recall an earnings report where they haven’t done this, and with 95% of their liquefaction capacity pre-sold it’s even more impressive. Since the war with Iran started at the end of February, LNG is +12% and has outperformed its sector by 9%, a tepid reaction from investors towards one of the biggest winners of the conflict.
VG is +33% since the end of February. The performance gap between the two stocks shows that investors are focused on the near-term arbitrage opportunity caused by Qatar’s force majeure. The long-term disadvantage of relying on gas shipments within range of Iranian missiles hasn’t yet resonated with the market.
NEXT is –40% over the past year. The perceived threat from outdated fears of a global gas glut still hasn’t completely dissipated, although it’s +23% since hostilities began. They expect to begin commercial deliveries early next year. The start of tangible revenues should attract more discerning investors.
Meanwhile, midstream investors are doing better under Trump 2.0 than Trump 1.0, albeit with the unintentional support of White House policies.
We have two funds that seek to profit from this environment: