Master limited partnerships (or MLPs) typically hold assets related to oil and natural gas pipelines and storage facilities. Unlike companies, MLPs don’t face taxes at corporate levels. Only unitholders have to bear the tax liability once they get their distributions.

The midstream infrastructure assets of MLPs are booked by shippers for long-term transportation and storage of natural gas and oil. In return, MLPs receive steady fee-based revenues, reflecting a low-risk business model.

Increasing demand for clean energy is leading to higher investments in natural-gas fired power plants, replacing coal units in the United States. The move should support natural gas production in the domestic market. Rising exports of natural gas will also add to the need for additional production of the commodity.

Moreover, recovering crude prices are encouraging explorers to bump up oil production. However, the domestic shale plays, especially the Permian Basin, are currently facing pipeline capacity constraint to transport additional crude and natural gas volumes. Hence, the rising need for fresh midstream infrastructures will continue to support MLPs to generate handsome operating cashflows.

Industry Lags on Shareholder Returns

Looking at shareholder returns over the past year, it seems that the pipeline bottleneck problem has been weighing on the industry of late. However, once additional midstream assets come online, we expect investors to gain confidence.

The Zacks Oil & Gas Production Pipeline MLP Industry, part of the broader Zacks Oil and Energy Sector, has underperformed both the S&P 500 and its own sector over the past year.

While stocks in this industry have collectively gained 1.3%, the Zacks S&P 500 Composite and Zacks Oil and Energy Sector have rallied 16.7% and 9.6%, respectively.

One-Year Price Performance

Group Has Room for Upside

Since partnerships use significant debt for funding operations, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric considers not just equity but also the level of debt.

Although overvalued as compared to both S&P 500 and its own sector, the industry still has room for upside. This is reflected by the fact that the industry’s current trailing 12-month (TTM) EV/EBITDA ratio of 13.14 is lower than one-year high mark of 14.46.

Enterprise Value/EBITDA Ratio (TTM)

The space looks expensive when compared with the market at large and the Oil and Energy sector, as the trailing 12-month EV/EBITDA ratio for the S&P 500 and its own sector are 11.78 and 5.93.

Enterprise Value/EBITDA Ratio (TTM)

Prospects Bright on Strong Earnings Outlook

Our proprietary model shows that through 2017, the industry’s net operating cashflow surged 30.2% to roughly $3 billion. Also, through the first-half of 2018, the company’s net-operating cashflow grew 12.7% to $3.4 billion.

To maintain the pace of improving cashflow, partnerships have been investing huge capital for new midstream infrastructures to capitalize on the pipeline bottleneck problem in the domestic market.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company’s earnings outlook significantly influences its stock performance.

While one can get a good understanding of a company's earnings outlook by comparing the consensus earnings expectation for the current financial year with the previous year’s reported number, an effective measure could be the magnitude and direction of the recent change in earnings estimates.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for it and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

Price and Consensus: Zacks Oil & Gas Production Pipeline MLP Industry

This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the $1.61 EPS estimate for the industry for 2018 is not the actual bottom-up dollar estimate for every company within the Zacks Oil & Gas Production Pipeline MLP Industry but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the industry’s earnings per share for 2018 but how this estimate has evolved recently.

Current Fiscal Year EPS Estimate Revisions

As you can see here, the EPS estimate for 2018 is up from $1.56 at the end of June and $1.57 at the end of September 2017. In other words, the sell-side analysts covering companies in the Zacks Oil & Gas Production Pipeline MLP Industry have raised their estimates.

Zacks Industry Rank Confirms Bullish Sentiment

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, paints an optimistic picture for the near term.

The Zacks Oil & Gas Production Pipeline MLP Industry currently carries a Zacks Industry Rank #94, placing it in the top 37% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Our proprietary Heat Map shows that the industry’s rank has been in the top 50% for the past eight weeks.

Notably, the industry has been witnessing improvement in the top line and earnings per unit – EPU since the beginning of 2017.

Revenues: Zacks Oil & Gas Production Pipeline MLP Industry

EPU: Zacks Oil & Gas Production Pipeline MLP Industry

Bottom Line

Since the near-term picture of the industry appears rosy, it would be prudent to focus on some prospective MLPs.

Here, we highlight four stocks which have witnessed upward earnings estimate revision in the last 30 days.

Based in Houston, TX, TC PipeLines LP (TCP - Free Report) owns stakes in natural gas transportation assets, which generate stable, recurring and low-risk earnings and cashflow. The Zacks Consensus Estimate for current-year EPU has been revised 1.6% upward in the past 30 days. Currently, it sports a Zacks Rank #1 (Strong Buy). 

Price and Consensus: TCP

Oasis Midstream Partners LP (OMP - Free Report) , based in Houston, TX, is a provider of midstream services. The Zacks Consensus Estimate for current-year EPU moved up 2.3% in the past 30 days. Currently, the stock has a Zacks Rank #2 (Buy).

Price and Consensus: OMP

Enable Midstream Partners LP (ENBL - Free Report) , based in Oklahoma City, OK, is among the leading operators of midstream energy properties. The Zacks Consensus Estimate for current-year EPU has improved 1% in the past 30 days. Currently, the stock carries a Zacks Rank #3 (Hold).

Price and Consensus: ENBL

Headquartered in Houston, TX, Enbridge Energy Partners LP (EEP - Free Report) is a provider of oil and gas transportation and gathering services. The Zacks Consensus Estimate for current-year EPU has been revised 5.7% upward in the past 30 days. Currently, the stock has a Zacks Rank #3.

Price and Consensus: EEP