Finding Value in a Growing Industry
In one of our recent market updates, we discussed that commodity prices are at historically low valuations. Energy, in particular, is one area that is trading at cheap valuations. When most people think about energy, they think of oil and how much they are paying at the pump. While oil does make up a large part of the energy sector, there are other aspects to energy besides oil. Natural gas and the pipelines used to transport both of these products are perfect examples. With the rise in the use of natural gas in the United States (in manufacturing, with utility companies and now exporting liquefied natural gas), we believe pipelines will significantly benefit from the increased use.
One way to invest in pipelines is through a Master Limited Partnership (“MLP”). The tax structure of a MLP is similar to that of a real estate investment trust. Pipeline MLPs are often referred to as “mid-stream” investments. Since oil prices collapsed in 2015, mid-stream earnings have increased 18% (see first chart below) while there have been significant earnings declines in other areas of the energy space. Even given the improving earnings picture, the price of MLPs has fallen since 2015 in line with other energy companies. As the second chart below demonstrates, pipelines are currently selling at a 30% discount to historical valuations and almost a 40% discount relative to next year’s earnings projections. On top of their excellent valuations, many mid-stream MLPs have an annual yield (which increases with volume increases) of approximately 8%.
What does this mean for your portfolio?
Mid-stream MLPs are the most compelling part of the market at this time. While almost every other sector is at historical overvaluation levels, MLPs are selling at historically low valuations and have a much higher yield than almost any investment. Having a President that is friendly to the space only makes it a more compelling investment. This is why we have a sizable investment in this space in our client portfolios.