WHAT’S MAKING HEADLINES
Market commentators have highlighted the narrowness of the market advance since 2023
The S&P 500, dominated by technology stocks and led by NVIDIA (NVDA-NYSE) has continued to march to new highs
Artificial intelligence (AI) and anticipation of the first cut in the fed funds rate populate the business headlines. Energy stocks have faded since making new highs in early April despite favorable fundamentals and attractive valuations, in our view
Oil prices, not too hot, not too cold, in a trading range of $70 to $90 per barrel, are high enough to support attractive returns for energy companies while not too high to choke demand
It cannot be stated strongly enough that the energy sector has embraced “financial discipline’ and eschewed “grow baby grow.” This results in strong balance sheets, more resilient cash flows, sustainable businesses, and better risk profiles. Ultimately, we believe the energy sector will be rewarded with better valuations and higher stock prices.
WE REMAIN BULLISH ON THE MIDSTREAM ENERGY SUBSECTOR
Midstream has compelling double-digit total return potential with attractive yield plus growth. These companies provide the infrastructure (such as processing plants and pipelines) to support U.S. production growth, energy consumption, and robust exports. As we noted in our April Commentary, midstream companies are poised to benefit over the next several years from the surge in power demand, liquified natural gas (LNG) exports, and petroleum exports (see key takeaways from our latest fireside chat with EPD later in the market commentary).
SAM’s Infrastructure Income Strategy supports a yield of ~4.5% plus income growth potential of 5-7%. We believe that there is room for multiples to expand particularly for midstream energy companies. Midstream c-corps are trading at EV-to-EBITDA multiple of 9.4x, which is below the 5-year and 10-year averages of 9.7x and 11.7x, according to Wells Fargo Securities. A 1.0 x multiple expansion implies ~20% upside.
The S&P 500 has gained 14.5% as of this writing while the Energy Sector (as measured by the S&P 500 Energy Index) has corrected 10% from its April 5th high and is up 9% year-to-date. Utilities (UTY-NYSE) have fared better, up 10.9%, as the sector is perceived as AI beneficiaries, and the midstream sector (AMNA-NYSE) has appreciated 12.2%.
ENTERPRISE PRODUCTS PARTNERS: THE EPITOME OF CONSISTENCY
Earlier in June, we were fortunate to host an engaging fireside chat with Co-CEOs, Jim Teague and Randy Fowler of Enterprise Products Partners L.P. (EPD-NYSE). Enterprise is one of the largest publicly traded partnerships and a leading North American provider of midstream energy services to producers and consumers of natural gas, natural gas liquids ("NGLs"), crude oil, petrochemicals, and refined products.
HIGHLIGHTS FROM OUR CONVERSATION:
1) A Dividend Aristocrat at Heart
I started the conversation by noting that EPD has a noteworthy track record of distribution increases. Structured as a master limited partnership (MLP), EPD cannot be included in the S&P 500 index and cannot qualify as a Dividend Aristocrat. However, EPD meets the criteria for inclusion, i.e., raising dividends annually for at least 25 consecutive years. EPD has done it 26 times and counting.
2) The World Has Never Done Energy “Transition”
The company has made the point before that global energy demand will continue growing and “all of the above” energy sources will be required. Population growth, in addition to lifting emerging nations from energy poverty, will require more energy as will the electrification of everything including data centers, cryptocurrencies, electric vehicles, etc. Demand for traditional energy sources will continue to grow as renewable sources are added to the mix.
In other words, it’s not an energy transition but rather energy “addition.”
Historical Energy Demands by Source vs. Population Growth
Sources: EPD Investor Deck presentation dated May 2024 and Our World in Data 2022, a collaborative effort between researchers at Oxford University and Global Change Data Lab; Statista
3) Production Growth Forecast
EPD has been more right than many others in their production forecasts. The Permian Basin is expected to be the growth engine and account for over 90% of U.S. production growth in oil, NGLs, and natural gas through 2030. You can see from the graphs below that production growth levels off in the back half of the decade.
Permian Production Forecasts
Source: EPD Fundamentals
4) Upstream M&A is Not a Bad Thing
The wave of upstream consolidation, e.g., ExxonMobil’s (XOM-NYSE) acquisition of Pioneer Natural Resources, Chevron’s (CVX-NYSE) pending acquisition of Hess Corp. (HES-NYSE), and Conoco Phillip’s (COP-NYSE) recently announced intent to acquire Marathon Oil (MRO-NYSE), is likely to be a net positive for the industry. The consolidation of contiguous acreage should lead to more efficient operations, lower costs, and ultimately more production.
5) Robust Growth in Energy Exports
EPD currently exports over 70 million barrels per month of petroleum liquids (crude oil and LPGs) or more than 20% of the U.S. total. Management has set a goal to reach 100 million barrels (but didn’t provide details to when) and noted that this target did not include SPOT.
6) Optimism about getting SPOT to FID this year
EPD’s SPOT (Sea Port Oil Terminal) is a deepwater port facility designed to load crude oil more quickly (up to 2 million barrels per day (b/d)), more cheaply, and in a more environmentally friendly manner. This past April the company received its deepwater port license. Given sufficient binding commitments, the company expects the project can be completed in about three years. EPD has not updated its original cost estimate of $1.85 billion but has repeatedly stated that it will be significantly less than $3 billion.
7) Remaining Consistent in Capital Allocation Priorities
EPD’s conservative financial approach has served the company well as evidenced by their enviable distribution track record. Don’t expect the approach to change. Management will prioritize growth investments if the projects meet its return hurdle rates that have typically averaged 12-13% (unlevered). The next two years’ growth capital spending is projected to stay in the range of $3.25-$3.75 billion annually and then fall to $2.0-$2.5 billion in 2026 (excludes the SPOT project that will be constructed over three years).
About 55-60% of adjusted cash flow from operations (CFFO) will be allocated to shareholders. Within that context, distributions are likely to grow 5-6% and opportunistic stock buybacks are likely to fall in the range of $200-$250 million.
Importantly, leverage is expected to remain relatively low in a debt to EBITDA range of 2.75 -3.25x. Finally, management likes to point out that EPD is the only midstream company to grow its adjusted CFFO per Unit and reduce its unit count without material asset sales.
MLP INSIGHT
EPD is structured as an MLP. Management believes that the MLP structure is a tax efficient way to return cash to shareholders, works well for estate planning purposes, and a conversion to a c-corporation is unlikely to significantly increase EPD’s stock price.
A FEW THOUGHTS ON OIL AND NATURAL GAS PRICES
We believe that oil prices are likely to remain range bound trading between $70 and $90 per barrel, absent a flare up in the Middle East. OPEC+ seems intent on providing a floor for oil prices and clarified its June 2nd announcement that initially sent prices lower. As announced, voluntary production cuts of 2.2 million barrels per day (mmbl/d) will be phased out monthly starting in Q4’24 through the end of Q3’25 (see the chart below). While the market initially focused on the phaseout of voluntary cuts, OPEC+ also agreed to extend the mandatory cuts one year through the end of 2025. Subsequent to its announcement, OPEC+ clarified that the phase out of its voluntary production cuts could be reversed should market conditions warrant it.
The outlook on crude oil prices is more muted given OPEC’s recent announcement to phase out production cuts.
Production Levels with the Phase-out of only November 2023 Voluntary cuts which will be applied starting from October 2024 until September 2025
Source: Organization of the Petroleum Exporting Countries
Oil demand is set to increase 1-1.5. mmb/d in 2024 and 2025, primarily from non-OECD countries led by China and India. In our view, oil prices are probably not sustainable above $90 per barrel because at that level, it could begin to choke demand and bring more OPEC+ barrels onto the market. The WTI spot price currently sits at ~$81/bl.
Notably, natural gas prices have increased steadily over the past two months, breaching the $2.50 MMBtu level as producers have curtailed production in the Marcellus and Haynesville basins. Natural gas prices are set to rise higher during the summer should hot weather persist and push electric power demand higher. Longer term, the rollout of AI data centers, electrification of the economy, and new LNG export terminals are expected to drive higher demand and prices for natural gas in the U.S. through the end of this decade, in our view.
Commodity Prices YTD 2024
Source: U.S. Energy Information Administration
MAY REVIEW: ENERGY UNDERPERFORMS AS THE MARKET RECOVERS IN MAY
The rundown:
SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 5.0% compared to 5.0% for the S&P 500 and 6.7% for its customized benchmark as of 5/31/24.
SAM’s Energy Transition Portfolio generated a return (net of fees) of 7.2% versus 9.1% for its customized benchmark as of 5/31/24.
Midstream was up in May with a total return of 3.9%, as measured by the Alerian Midstream Energy Index (AMNAX).
Utilities and the clean energy sector outperformed, generating a total return of 9.0% and 12.7%, as measured by the Philadelphia Stock Exchange Utility Index (XUTY) and the S&P Global Clean Energy Index (SPGTCLTR), respectively.
In May, 10 out of 11 sectors in the S&P 500 reported a positive performance with information technology as the best performer and energy as the worst. Energy delivered a -0.4% monthly total return. May month-end WTI crude oil and Henry Hub natural gas prices were $78.96 per Bbl and $1.68 per MMBtu, down ~5% and up ~6%, respectively from last month.
2024 Year-To-Date Total Return
Source: Bloomberg, NASDAQ and S&P Global
RESULTS: SINCE INCEPTION & ONE YEAR
SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 86.9% and 24.9% for the periods since 11/10/20 inception and 1-year, respectively. This compares to a total return of 80.0% and 18.8%, respectively, for its customized benchmark and 57.3% and 28.2%, respectively, for the S&P 500 as of 5/31/24.
SAM’s Energy Transition Portfolio generated a return (net of fees) of 11.0% and 7.0% for the periods since 4/29/21 inception and 1-year, respectively. This compares to a total return of 9.6% and 5.0%, respectively, for its customized benchmark and 31.5% and 28.2%, respectively, for the S&P 500 as of 5/31/24.
Sam Partners’ Infrastructure Income and Energy Transition Strategies seek to provide sustainable income and growth with capital preservation. This is accomplished by investing in a concentrated portfolio of high-quality midstream energy companies, utilities and clean energy companies that are well positioned to participate in the energy transition to a net zero carbon future. A diversified approach to investments across these sectors should optimize risk-adjusted returns, in our view. Our Infrastructure Income Strategy offers investors a current yield of ~4.5% and growth potential of ~5-7%; while the Energy Transition Strategy that is more heavily weighted with clean energy stocks and aligns with favorable ESG ratings, offers investors a current yield of greater than 4%. In a world searching for yield, we believe these Strategies offer a compelling value proposition.
IMPORTANT DISCLOSURES
Siegel Asset Management Partners is a registered investment adviser located in Plainview, New York. The views expressed are those of Siegel Asset Management Partners and are not intended as investment advice or recommendation. This material is presented solely for informational purposes, and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness, or reliability. All information is current as of the date of this material and is subject to change without notice. Third-party economic, market or security estimates or forecasts discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates or forecasts. Certain products and services may not be available in all jurisdictions or to all client types. Unless otherwise indicated, Siegel Asset Management Partners' returns reflect reinvestment of dividends and distributions. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
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