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Offset Some Inflation Impact With 5 Energy Pipeline Buys

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·6 min read
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Wall Street has been reeling under extreme volatility since the beginning of 2022. Investors are highly concerned about soaring inflation. While an aggressive Federal Reserve is trying to get things under control by hiking the interest rate (already a record-high 75 basis points in June and possibly the same in July), it continues to rage on and is now at a fresh 40-year high.

For investors, who have seen their holdings erode amid the price rise, one of the key themes is to use the energy pipeline space to wade through this period of macro volatility. In this context, investing in the likes of Sunoco LP SUN, Enterprise Products Partners L.P. EPD, Delek Logistics Partners, LP DKL, Global Partners LP GLP and CrossAmerica Partners LP CAPL might offer some respite to investors.

Inflation Affects Purchasing Power

In the United States, several measures of inflation are currently at the 40-year high levels. The outbreak of coronavirus has significantly devastated the global supply-chain system in the last two years. Input costs have soared for businesses, while wages have gone up owing to the shortage of labor. At the same time, strong pent-up demand, supported by massive personal savings during this period, has resulted in soaring prices.

Market participants are highly concerned that inflation will remain elevated in the near term. At present, the lingering war between Russia and Ukraine is the biggest threat to the global economy. As long as this war continues, the chances are bleak that we will get rid of the soaring inflation.

While the cost of going to the supermarket or ordering meals from restaurants has clearly spiked for consumers, another worrying side effect of inflation is that it eats into the returns generated by financial instruments such as equities and bonds by eroding their value.

Allaying Inflation Concerns

A particular asset class that possesses attributes to combat the value destruction from inflation is energy midstream. These entities typically operate transportation services, storage facilities and refined products' terminals. They are often structured as Master limited partnerships (or MLPs), which differ from regular stocks since interests in them are referred to as units, and unitholders (not shareholders) are partners in the business. Importantly, these low-risk hybrid entities bring together the tax benefits of a limited partnership with the liquidity of publicly traded securities that earn a stable income.  

Let’s check out the underlying rationale for owning midstream companies during periods of rising consumer prices

Midstream to the Rescue

Inflation Indexation: A salient feature of these entities is that the bulk of their cash flows are under long-term, fee-based contracts, which are indexed to inflation. In other words, midstream operators fix tariff rates in accordance with FERC regulations tied to the Producer Price Index — a measure of changes in prices covering a host of goods and services. Consequently, pipelines can pass on at least a portion of the higher costs to customers.

Real Assets: The properties that these entities own are mostly pipelines and storage facilities, or infrastructure systems that help in moving oil and natural gas. Unlike stocks and bonds, midstream firms own real (physical) assets that do not derive their value from a contractual right. Their intrinsic worth has been historically proven to outperform traditional stock and bond instruments in years when inflation is high. That is because the economy is healthier and demand for real assets rises.

Distribution Growth: Apart from defensive characteristics, investors are typically attracted to MLPs for their reliable distributions. Adjusting costs with the prevailing business activity, the partnerships have focused on the generation of free cash flow (post distribution payment) to lower debt and strengthen their financial position. The growing free cash flows could be used to boost investor returns through buybacks and distribution hikes. Finally, the distribution growth, which often ranges in double digits, can also help investors to offset some of the impacts of high inflation.

5 Pipeline Choices

To guide investors to the right picks, we highlight four pipeline firms that carry a Zacks Rank of #1 (Strong Buy) or 2 (Buy). The Zacks Rank is a reliable tool that helps you to trade with confidence regardless of your trading style and risk tolerance. To learn more about how you can use this proven system for market-beating gains, visit Zacks Rank Education.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Sunoco LP: Sunoco participates in the transportation and supply phase of the U.S. petroleum market across a number of states. It also focuses on motor fuel distribution to convenience stores, independent dealers and commercial customers.

SUN pays out 82.55 cents quarterly distribution ($3.302 per unit annually), which gives it an 8.9% yield at the current unit price. Sunoco beat the Zacks Consensus Estimate for earnings twice in the trailing four quarters, the average being 51.6%. Valued at around $3.7 billion, Zacks Rank #1 SUN has lost some 1.9% in a year.

Enterprise Products Partners L.P.: This leading energy infrastructure firm boasts an extensive network of pipelines that spreads more than 50,000 miles and connects to every major U.S. shale play. Almost 80% of its pipeline contracts with shippers have been extended for 15-20 years, which will help EPD generate steady cash flow for unitholders.

The Zacks #1 Ranked partnership has an expected earnings growth rate of 14.3% for the current year. Enterprise Products Partners pays out a 46.5-cent quarterly distribution ($1.86 per unit annually), which gives it a 7.7% yield at the current unit price. EPD units have edged up 0.3% in a year.

Delek Logistics Partners, LP: The firm is engaged in the gathering, transportation, storage and distribution of crude oil, intermediate products, feedstocks and refined products, and is also into wholesale marketing.

DKL pays out 98 cents quarterly distribution ($3.92 per unit annually), which gives it an 8.5% yield at the current unit price. Delek Logistics beat the Zacks Consensus Estimate for earnings twice in the trailing four quarters, the average being 1.3%. Valued at around $2 billion, #1 Ranked DKL has gained some 9.1% in a year.

Global Partners LP: GLP is a vertically integrated energy partnership focused on the distribution of gasoline, distillates, residual oil and renewable fuels, apart from owning several refined-petroleum-product terminals. Unlike most energy operators, which maintained their payout through the coronavirus-induced downturn, Global Partners is among the minority that continued to increase distributions.

The gasoline station and convenience store operator has an expected earnings growth rate of 163.4% for the current year. GLP pays out 59.50 cents quarterly distribution ($2.38 per unit annually), which gives it a 10.4% yield at the current unit price.

CrossAmerica Partners LP: Wholesale distributor of motor fuels CrossAmerica Partners’ variable rate margins helped it offset the loss in volumes during the pandemic. Further, CAPL’s recent acquisitions of retail and wholesale assets provide it with a wider reach and scale.

The 2022 Zacks Consensus Estimate for this Allentown, PA-based firm indicates 64.9% year-over-year earnings per unit growth. CrossAmerica Partners beat the Zacks Consensus Estimate for earnings in two of the last four quarters. The Zacks Rank #2 stock has a trailing four-quarter earnings surprise of roughly 8.7%, on average. CAPL shares have moved up a modest 1.3% in a year.


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