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Worried Over Interest Rates? Check Out 3 Oil Pipeline Stocks

With the current banking chaos and stubborn inflation, the Federal Reserve concluded its two-day policy meeting on Wednesday by sticking to its plot and raising interest rates by another 25 basis points. This brings the Fed funds rate range to 4.75-5.00% — the highest level since 2007.  

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 MPLX LP MPLX, Magellan Midstream Partners MMP and Enterprise Products Partners EPD might offer some respite to investors.

Inflation Affects Purchasing Power

In the United States, several measures of inflation show it to be more stubborn than previously expected. Despite some moderation from last summer’s 40-year high level, inflation continues to be entrenched.

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 banking crisis and the lingering war between Russia and Ukraine are the biggest threats to the global economy. As long as the uncertainties persist, chances are bleak that we will get rid of the elevated 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 is 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. This 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.

3 Pipeline Operators You Need to Know

We bring here three energy pipeline firms with high yields that could be used as an inflation hedge.

MPLX LP: MPLX owns and operates gathering and processing assets along with crude transportation and logistics infrastructure. The partnership, which is valued at around $34.1 billion, carries a Zacks Rank #3 (Hold). MPLX has edged up 1.8% in a year.

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

The energy infrastructure provider has an expected earnings growth rate of 7.7% for the current quarter. MPLX pays out 77.50 cents quarterly distribution ($3.10 per unit annually), which gives it a 9.1% yield at the current unit price. (Check MPLXs distribution history here)

Magellan Midstream Partners: This leading energy infrastructure firm has the longest refined petroleum pipeline system in the United States, with access to almost half of the total domestic refining capacity. MMP primarily transports, stores and distributes refined petroleum products and, to a lesser extent, ammonia.

This Zacks Rank #3 partnership has an expected earnings growth rate of 5.7% for the current year. MMP pays out a $1.0475 quarterly distribution ($4.19 per unit annually), which gives it an 8% yield at the current unit price. MMP units have gained 3.2% in a year. (Check Magellan Midstream Partners' distribution history here)

Enterprise Products Partners: The firm is among the leading midstream energy players in North America. With its wide base of midstream infrastructure assets, EPD provides services to producers and consumers of commodities that include natural gas, natural gas liquids (NGL), oil and refined petrochemical products.

Enterprise Products Partners pays out 49 cents quarterly distribution ($1.96 per unit annually), which gives it a 7.8% yield at the current unit price. EPD has an expected revenue growth rate of 6.1% for the current quarter. Valued at around $54.5 billion, the partnership, a #3 Ranked stock, has lost 1.2% in a year. (Check Enterprise Products Partners' distribution history here)

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