The energy sector has recently received a much-needed boost as the war in Ukraine and rising tensions with Iran have jeopardized the global energy supply chain. This, in turn, drove up energy prices, strengthening companies in the sector.
Although midstream companies are less sensitive to commodity prices than energy producers like Exxon Mobil (XOM), for example, they still benefit from rising energy prices for the following reasons:
Some of their cash flows are sensitive to commodity prices.
Rising energy prices strengthen their customers financially, thereby securing their contracts.
Higher energy prices improve the economics of energy production, thereby increasing the demand for intermediate energy infrastructure.
For income investors looking for a combination of safe high yield and stable long-term income growth potential in the middle space, two heavyweights that immediately come to mind are MPLX (NYSE: MPLX) and energy transfer (NYSE: AND). Both have touted midstream infrastructure portfolios that play a critical role in the North American energy industry and offer high, well-hedged returns.
What is the best buy today? In this article, we’ll compare them side-by-side to show why we think ET is winning the battle right now.
MPLX stock is fairly valued
MPLX has a portfolio of high-quality assets that has weathered the COVID-19 energy crisis quite well. It owns gathering and processing assets, natural gas and NGLs transportation, fractionation, storage and marketing assets, crude oil and refined products transportation, storage and distribution assets, and owns refining and fuel distribution logistics activities.
That said, its asset growth outlook has diminished significantly since the COVID-19 outbreak, as it cut its growth capital budget in 2020 and 2021 while prioritizing redemptions and distributions over investment expenditure. In 2020 they spent $1 billion in total capital expenditure, in 2021 they only spent $600 million, and in 2022 they are expected to reach $900 million. For comparison, they spent $2.5 billion in 2018 and $2.7 billion in 2019 on CapEx.
MPLX’s balance sheet is strong, as evidenced by its strong S&P investment grade BBB credit rating, low net debt to EBITDA ratio of 3.66x (well below management’s 4x target), hedging 7x EBITDA interest, over $3.2 billion in cash and a well-laddered scale of debt maturities.
Meanwhile, distribution remains the high point of MPLX’s investment thesis, with a forecast return of 8.6% hedged at 1.45x by 2021 of distributable cash flow. Management has signaled that it intends to increase distribution by 5% in 2022.
That said, the dissertation assessment component is a bit less appealing. It is currently trading at one EV for a forward EBITDA of 9.74x, which is well above its 3-year (9.00x) and 5-year (9.33x) averages. Meanwhile, it’s trading at 7.3x expected distributable cash flow for 2022. While that’s not high prices for the stock, it doesn’t look like a bargain compared to its history either. Additionally, as we will see shortly, there is another investment grade mid-tier firm trading at a considerable discount MPLX.
ET stock is significantly undervalued
ET also has a well-diversified, high-quality portfolio of assets. In fact, his portfolio is one of the largest in North America, with a focus on Texas and the Midwest. Its extensive network of pipelines currently serves nine of the top 10 production basins in the United States, with cash flows from a diverse assortment of sources:
Combining its size, geographic diversification, asset diversification, and the fact that 90% of its forecast adjusted EBITDA for 2022 comes from fee-based contracts, ET’s cash flow profile is quite stable.
As with MPLX, ET’s growth prospects are slowing. Although it has significant projects to bring online in the near future, its investments in growth CapEx are also declining significantly as it increasingly prioritizes debt repayment and increasing its distribution. .
ET’s balance sheet – while not as strong as MPLX’s – is still quite strong with a BBB- credit rating from S&P. Meanwhile, it paid off a whopping $6.3 billion in long-term debt in fiscal 2021 and plans to continue paying down debt aggressively in 2022 and beyond.
The biggest thing to love about ET is that it’s a cash flow machine. While its forward payout yield of 6.9% is not to be overlooked, it currently boasts a distributable cash flow yield of 22.3%, which is good for a whopping 3.2x payout coverage on the basis of the current annualized distribution rate. On top of that, management said restoring the distribution to its pre-cut rate of $1.22 is a “top priority” and – given the recently strengthened balance sheet, capital expenditure cuts and massive yield of distributable cash flow, that would seem to be very doable. In fact, if ET were to restore their distribution to $1.22 today, the 2022 hedge based on the projected DCF would be very conservatively 1.84x, allowing them to continue to fund CapEx growth and repay the debt in addition to paying the distribution.
Finally, ET’s valuation metrics make it a much more attractive investment than MPLX at present. In addition to trading at a price well below the DCF ratio (4.5x compared to MPLX’s 7.3x), its target payout rate of $1.22 would put the payout yield at 12.1%, which is far superior to the performance of MPLX. Finally, ET’s EV/EBITDA ratio is significantly lower than MPLX’s (8.05x compared to MPLX’s 9.74x and lower than ET’s 5-year average of 9.43x).
Key takeaway for investors
There’s a lot to like about both MPLX and ET, as they both have quality midstream infrastructure portfolios and stable cash flows supported by conservatively positioned balance sheets. While MPLX has a better balance sheet, a slightly stronger balance sheet and a higher yield at present, ET clearly has the upper hand in terms of valuation as well as a better diversified portfolio of assets. We also like that ET has the potential to outperform MPLX’s distribution yield and even balance sheet strength in the near future, as its vastly superior distributable cash flow yield allows it to quickly deleverage and grow its distribution in a way that MPLX cannot match.
While we wouldn’t mind holding both MLPs given their massive yields and stable cash flow profiles, we are quite selective at High Yield Investor. Accordingly, we have opted for ET and excluded MPLX for the time being.