If you’re looking to put $2,000 to work in this market, midstream energy stocks are a smart place to look. They tend to offer stable, fee-based cash flows, have high yields, and are seeing good growth opportunities. The sector is also trading well below historical valuations compared to a decade ago, despite the companies being in better financial shape.
Let’s look at three smart midstream investment options to buy right now.
Energy Transfer
In my view, Energy Transfer (ET -0.23%) is one of the most compelling risk/reward stocks in the market today, which is why it’s one of my largest personal holdings. It combines a high yield, improving financial profile, and solid growth opportunities. Despite this, it also trades at one of the lowest valuations in the space.
The company has spent the past few years improving its balance sheet and getting in better financial shape, and now it’s set to reenter growth mode. It cut its distribution back in 2020 to get its debt under control, and since then, it’s used free cash flow to help fund growth and lower its leverage. Its leverage is now at the low end of its targeted range, and management recently called its balance sheet the strongest it’s ever been. That gives it flexibility as it enters growth mode, something it didn’t have during its last big investment cycle.
At the same time, 90% of its EBITDA (earnings before interest, taxes, depreciation, and amortization) is fee-based, with many contracts structured as take-or-pay. That gives it a recurring revenue stream that is largely insulated from commodity prices. Last quarter, its distributable cash flow (operating cash flow minus maintenance capital expenditures) covered its distribution by more than 2x, which leaves plenty of room for continued hikes. Management has already raised the distribution for 14 straight quarters, taking it back above pre-cut levels, and is targeting 3% to 5% annual growth going forward.
Energy Transfer is also back in growth mode, with $5 billion in growth project spending planned this year compared to $3 billion last year. This includes projects aimed at supplying natural gas to artificial intelligence (AI) data centers and liquified natural gas (LNG) exports, which are two secular trends just getting started.
Despite all of this, the stock trades at a forward enterprise value-to-EBITDA multiple of just 8, which is the most common method for valuing midstream stocks. That’s too cheap for a stock with this kind of financial strength, a 7.5% yield, and strong upside potential. As such, this is a stock that belongs in long-term portfolios.
Enterprise Products Partners
Enterprise Products Partners (EPD 0.38%) is the type of company you can build a portfolio around. In fact, it’s one of the stocks that I’ve held the longest. It has a long track record of distribution growth, operates in attractive markets, and runs a conservative balance sheet. It’s not a stock that is going to double in a year, but it can provide you with a steady, rising income stream over a long period of time.
Enterprise has increased its distribution for 26 straight years, and it has a current yield of around 6.9%. It raised its payout nearly 4% last quarter, and I would expect it to increase it by a similar percentage moving forward. That’s the kind of compounding that adds up in a big way over time.
Enterprise’s business is also built for consistency. Historically, around 85% of cash flow comes from fee-based contracts, with many of them structured with take-or-pay terms and annual inflation escalators. This helps provide steady cash flows even in volatile energy markets.
One of Enterprise’s strongest areas is natural gas liquids (NGLs), where it’s one of the biggest integrated players in the country. It operates across the entire value chain — from gathering to processing to exports — and demand for NGLs continues to grow globally.
The company has always run a conservative balance sheet. Leverage sits at just over 3x, and the distribution is well covered with a 1.7x coverage ratio. It largely self-funds growth, so there’s no need to tap the capital markets for every project.
For long-term investors, Enterprise is a “sleep-well-at-night” stock.
Image source: Getty Images.
Genesis Energy
Genesis Energy (GEL 0.53%) doesn’t have the massive integrated midstream systems that Energy Transfer and Enterprise have, nor their track records. However, it’s in the midst of a strategic shift that could unlock a lot of value. For investors willing to stomach a bit more risk, it has strong potential upside. One of my best midstream investments of all time was Crestwood (since bought by Energy Transfer), and Genesis has similar vibes.
The company’s big move came when it sold its soda ash business, bringing in $1.4 billion in proceeds. Genesis immediately used that to clean up its balance sheet, retiring high-cost debt and preferred units. UBS estimates that this move will save the company $84 million a year in interest expense and preferred dividends, helping lead to a meaningful boost to cash flow.
The company’s focus will now shift to its offshore pipeline assets. Two large deepwater projects in the Gulf of Mexico with connections to its offshore pipeline system are set to come online soon. Together, they could add up to $150 million in annual operating profit.
At the same time, its marine transportation business is on track for record earnings this year, while offshore volumes are recovering from prior mechanical issues. All of this positions Genesis for much stronger cash flow going forward.
Right now, the stock’s yield sits at around 3.9%, but as these new projects ramp up, Genesis should have room to raise the distribution materially over time.
This isn’t the safest midstream stock you can buy, but it may have some of the biggest upside, even after its strong run this year.