MIDSTREAM ENERGY STOCKS DECOUPLE FROM WEAK COMMODITY PRICES AND CONTINUE TO SHINE
Spoiler alert: The number 1 reason that midstream stocks have done so well, in our view, is that investors have realized that infrastructure companies fit well with the AI (artificial intelligence), data centers, and growth in power demand thematic. Midstream companies will build the required infrastructure to enable this thematic to play out and are poised to do very well over the long term.
What is the midstream energy subsector—and why have the stocks done so well this year?
The midstream energy subsector includes infrastructure companies that process, transport, and store natural gas, natural gas liquids, crude oil, and refined petroleum products. As David Slater, CEO of DT Midstream, Inc. (NYSE: DTM), noted in our recent fireside chat (more on that to follow), the evolving energy transition narrative now acknowledges the ongoing need for reliable and affordable energy. Renewables like wind and solar can’t expand fast enough to satiate the world’s growing thirst for energy—this means that oil and natural gas remain essential for a very long time. This growing demand boosts the value of midstream assets, which generate stable cash flows and are hard to replace due to strict permitting and legal hurdles that prevent new infrastructure (e.g., pipelines) from being built.
Year-to-date, the midstream sector has generated a total return of nearly 34% (as of 10/15/24), as measured by the Alerian Midstream Energy Index (AMNAX). We note that natural gas-focused companies such as DTM (up over 61%) have led the group higher. This despite the pullback in commodity prices with natural gas currently at $2.37 per MMBtu, down ~8% year-to-date. The midstream performance has outperformed the S&P 500 (total return of about 23%) and the overall energy sector. The latter, heavily impacted by commodity prices, is the worst performing of the 11 S&P 500 sectors with a total return of less than 11% year-to-date.
Midstream Outperformance
Source: S&P Global, Bloomberg, EIA and Yahoo Finance
As noted above, the price performance of midstream energy stocks has decoupled from lower commodity prices and the overall energy sector—let’s look at some reasons for this:
Commodity price exposure: Midstream companies have very little and some like DTM have virtually none
Producer customers have demonstrated financial discipline and resilience: When oil prices collapsed in 2015, it was greatly feared that midstream companies would have collateral damage as some of their major upstream customers faced bankruptcy. Today, these energy customers are much stronger with pristine balance sheets and significantly lower cost structures that can withstand much lower commodity prices.
Supply and demand economics: Midstream companies benefit from moving ever greater volumes of oil and natural gas—however, if supply outpaces demand growth, prices weaken
Contract structure: Most contracts stipulate minimum volume commitments that provide downside protection for midstream companies
Growth is a good thing: Companies are only just now being rewarded for increasing growth capital expenditures as opposed to the recent past when new project announcements were greeted with lower stock prices. Why? Most new growth projects are backed by long-term customer commitments with attractive returns on investments. Several years ago, investors were concerned that new capital investments would lead to stranded assets, generate poor returns, and destroy shareholder value. As noted, the narrative has flipped and project announcements that support data centers and power demand have resulted in higher stock prices.
Scarcity value: Existing infrastructure is irreplaceable and will need to be expanded to keep pace
Midstream and utilities: Utilities is the second-best performing sector in the S&P 500 with total returns approaching 30%. Like their midstream cousin, utilities are beneficiaries of the expected growth in data centers and power demand. They are seen as defensive investments because of the inelastic demand for energy and their relatively high and growing dividends. Utilities sport a dividend yield of ~3%, midstream ~6%, and the S&P 500 ~ 1.5%. Dividend growth for utilities and midstream should approximate 5-7% for most companies and in-line with the broader market.
FIRESIDE CHAT WITH DAVID SLATER AND JEFF JEWELL
SAM’s Infrastructure Income and Energy Transition Strategies favor companies leveraged to improving natural gas fundamentals. Recently, we hosted a Fireside Chat with the CEO, David Slater and CFO, Jeff Jewell of one such company: DT Midstream, Inc. (DTM- NYSE). Below are tidbits from our discussion.
Who is DTM? DTM is a pure-play integrated natural gas company with assets in the two most prolific dry natural gas basins in the United States, Appalachia and the Haynesville in Louisiana. Natural gas from Appalachia is well positioned to supply the anticipated growth in power demand from data centers, while the Haynesville is an important source of supply to LNG export facilities.
KEY TAKEAWAYS FROM FIRESIDE CHAT:
1. Long term looks bullish. Management is bullish (as are we) on the longer-term outlook for natural gas demand tied to the anticipated growth in power consumption and exports, specifically LNG (we would also add that pipeline exports to Mexico are also increasing). Power demand is forecasted to grow ~ 2% annually into the next decade and there is approximately 7 Bcf per day of LNG export facilities that are slated to come into service over the next 12 to 18 months. Onshoring of industry is another growth driver that may have gone unnoticed.
DTM’s Assets to Benefit from Growing LNG and Power Demand
Sources: DT Midstream Company Presentation – October 2024, S&P Global Commodity Insights, Wood Mackenzie North America Gas Investment Horizon Outlook – October 2023
A stellar track record. DTM has a project backlog of greater than $1.3 billion, 60% of which is devoted to its pipeline segment, 20% to gathering, and 20% to clean energy. Importantly, DTM has established a track record of under promising and over delivering.
The data center opportunity is real. The company is in discussion with multiple parties to provide natural gas to future data centers.
Not too concerned about the election outcome. The biggest issue for the midstream sector (and the power market) is permit reform—and that has bi-partisan support. Energy and power infrastructure development is necessary to meet the anticipated growth in natural gas and power demand.
The energy transition narrative has been tempered. There is growing recognition that affordability and reliability must also be considered in the energy mix. We’re proud to note that the United States produces the cleanest oil and natural gas in the world due to its focus on reducing emissions.
Carbon capture and sequestration (CCS). An essential element of the company’s clean energy strategy, federal tax credits help to make these projects economically viable.
Investment grade balance sheet. DTM’s credit rating was recently upgraded to investment grade by Fitch and Moody’s has the company’s credit rating on positive outlook. Management expects to finance its capital expenditures with internally generated funds and has no need for external capital.
Consolidation opportunities. DTM has amassed an enviable track record of opportunistic acquisitions. However, given its organic growth backlog, the company does not need acquisitions to meet its annual earnings growth target of 5-7% (it’s grown at ~9%).
SEPTEMBER REVIEW: ENERGY CONTINUES TO UNDERPERFORM
The rundown:
In September, SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 1.5% compared to 2.1% for the S&P 500 and 2.2% for its customized benchmark as of 9/30/24. Year-to-date, SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 25.4% compared to 22.1% for the S&P 500 and 21.9% for its customized benchmark as of 9/30/24.
In September, SAM’s Energy Transition Portfolio generated a return (net of fees) of 1.1% versus 2.6% for its customized benchmark as of 9/30/24. Year-to-date, SAM’s Energy Transition Portfolio generated a return (net of fees) of 12.2% versus 12.0% for its customized benchmark as of 9/30/24.
Midstream was up in September with a total return of 0.6%, as measured by the AMNAX.
In September, utilities and the clean energy sector outperformed, generating a total return of 6.3% and 2.9%, as measured by the Philadelphia Stock Exchange Utility Index (XUTY) and the S&P Global Clean Energy Index (SPGTCLTR), respectively.
Except for energy, healthcare and financials, all sectors in the S&P 500 reported positive performance with consumer discretionary as the best performer and energy as the worst. Energy delivered a -2.7% monthly total return. September month-end WTI crude oil and Henry Hub natural gas prices were $68.75 Bbl and $2.65 per MMBtu, down ~4% and up ~3%, respectively from last month.
RESULTS: SINCE INCEPTION & ONE YEAR
SAM’s Infrastructure Income Portfolio produced a return (net of fees) of 104.9% and 29.5% for the periods since 11/10/20 inception and 1-year, respectively. This compares to a total return of 101.1% and 30.2%, respectively, for its customized benchmark and 72.6% and 36.4%, respectively, for the S&P 500 as of 9/30/24.
SAM’s Energy Transition Portfolio generated a return (net of fees) of 13.1% and 13.3% for the periods since 4/29/21 inception and 1-year, respectively. This compares to a total return of 19.1% and 19.9%, respectively, for its customized benchmark and 44.3% and 36.4%, respectively, for the S&P 500 as of 9/30/24.
2024 Year-To-Date Total Return
Source: Bloomberg, NASDAQ and S&P Global
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 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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