Introduction
By now, I doubt that it may come as a surprise to many readers when I say that I have started to like the midstream industry a lot in recent years.
While the industry was total dead money before 2021 due to elevated capital spending and subdued income, it has grown into one of my favorite places to be for both income and growth.
For example, Antero Midstream (AM) has become a top-3 position in my portfolio after I spent a lot of money building a position in the past two months.
Another stock I love in this industry is MPLX LP (NYSE:MPLX), the midstream giant owning pipelines and related assets for Marathon Petroleum (MPC).
The only reason why I do not own MPLX is the fact that it is a Master Limited Partnership, which issues a K-1 form. As a non-US-based investor, it’s tricky to deal with these financial vehicles, which is why I stick to C-Corps in the midstream industry.
My most recent article on MPLX was written on November 6, titled “Buy Income – MPLX’s 9.4% Yield Is A Good Place To Start.”
Since then, the stock has returned 11.5%. However, even excluding dividends, it has risen by 9.1%, which shows that MPLX is, indeed, more than an income vehicle!
Over the past three years, MPLX has returned 115% – 61 points of this performance came from capital gains.
With that said, in my prior article, I discussed the importance of buying income, as I believe that we are dealing with a mix of unfavorable headwinds, including a weakening economy, which is usually better for companies that return most of their cash to shareholders.
On top of that, I have written countless articles (including my 2024 Outlook) on the importance of buying value in an environment where the market, in general, has a lofty valuation.
In this article, I’ll reiterate my bullish thesis on MPLX, using its latest earnings and new developments to explain why MPLX may be one of the best 9%-yielding stocks on the market.
So, let’s get to it!
Buying 9% Midstream Income
When it comes to midstream companies, we’re dealing with companies that connect oil drillers to their customers. Without the pipelines, processing, and export facilities of midstream companies, oil and gas drilling would not be possible.
Here’s an example of the importance of midstream in connecting upstream to downstream operations from The Williams Companies (WMB).
This is why I am (with a background in supply chains) so fascinated by this industry, as it shows just how important pipelines are.
Having that said, when it comes to midstream operations, I care for a number of things, including (but not limited to) buying juicy income with healthy payout ratios, decent growth to fund future dividend growth, and healthy balance sheets to reduce financial risks.
When done correctly, investors can enjoy a number of benefits that come with owning midstream companies:
- High dividend yields: Midstream companies like MPLX often offer dividend yields that most high-yield stocks cannot compete with.
- Reliable dividend payouts: Midstream businesses typically generate stable cash flows due to long-term contracts with producers and shippers. This predictability allows them to distribute consistent dividends to shareholders.
- Growth potential: Companies with room to grow their dividends suggest the potential for capital appreciation in addition to the attractive income stream.
- Energy demand: While the long-term outlook for fossil fuels may be uncertain due to the energy transition, near-term demand for oil and gas remains strong, which means the demand for energy infrastructure will likely continue to be strong for a very long time.
With that in mind, MPLX has a $39 billion market cap, making it one of the biggest players in its industry. It operates two segments: Logistics and Storage (L&S) and Gathering and Processing (G&P).
MPC owns 65% of the company’s general partner shares and accounts for 47% of its revenue.
While some may make the case that this dependence is a bad thing, I believe it’s great, as MPC is the largest pure-play refinery company in the United States and allows MPLX to benefit from better demand and capital spending visibility.
Based on this context, the company benefits from two things:
- Its existing asset base.
- Growth opportunities.
For example, in the fourth quarter, the company reported stellar numbers.
In the L&S segment, the company achieved record pipeline throughput, driven by solid demand from customers and efficient operational management.
The overview below shows a few key numbers.
In the G&P segment, record throughput was observed in gathering, processing, and fractionation operations. This was primarily driven by assets located in major basins, like the Marcellus and Permian.
Moreover, processing volumes saw a significant 9% year-over-year growth rate, which the company attributed to increased demand.
To be specific, the Marcellus basin, the largest area of G&P operations, saw robust volume increases of 10% for gathering and 9% for processing, driven by escalated drilling and production growth.
Adding to that, low development costs in the Marcellus and Utica basins, combined with high process utilization rates, contributed to increased volumes.
Similarly, the Permian Basin saw attractive crude prices and growing gas production, further supporting volume growth.
On a side note, as some readers may know, the Permian is currently the number one basin for oil production growth, with increasing associated gas volumes.
As a result of these developments, total adjusted EBITDA reached $1.6 billion, which marks a significant 12% increase compared to 4Q22.
Additionally, distributable cash flow reached $1.4 billion, which translates to a 9% growth rate.
Meanwhile, the balance sheet showed continued improvement, with MPLX leverage now standing at 3.3x (EBITDA), which indicates prudent debt management and support for its investment-grade BBB credit rating.
Moreover, MPLX’s robust balance sheet, supported by a year-end cash balance of $1 billion, put the company in a great position to pursue strategic investments for future growth.
Going forward, the company aims for mid-single-digit growth rates over multiple years, supported by strategic capital deployment.
While this is not official guidance, MPLX’s track record (see below) of consistent growth in adjusted EBITDA and distributable cash flow reflects its ability to execute its growth strategy effectively and on a very consistent basis – despite temporary headwinds.
Moreover, with a focus on high-return growth projects in key basins such as the Marcellus and Permian, MPLX intends to capitalize on favorable market conditions and operational efficiencies to drive cash flow growth.
So, what does this mean for its dividend/distribution?
As we can see in the slide below, the company hiked its dividend by 10% last year (on October 24), returning $3.3 billion to shareholders.
The dividend/distribution had a 1.6x coverage ratio, which implies a low-to-mid 60% payout ratio.
MPLX currently pays $0.85 per unit per quarter. This translates to a yield of 8.6%.
It has never cut its dividend (unlike many peers) and has a five-year dividend CAGR of 5%.
Going forward, we can expect dividend growth to remain in the mid-single-digit range.
I will elaborate on that in the next part of this article.
Valuation
Analysts are upbeat about MPLX’s future.
Here are the expected operating cash flow (“OCF”) growth rates for the next three years (using data from the FAST Graphs chart below):
Year | OCF Growth |
2024E | 8% |
2025E | 2% |
2026E | 3% |
This bodes well for its valuation.
Using the data in the chart below again:
- MPLX trades at a blended P/OCF ratio of 7.3.
- Its normalized long-term valuation multiple is 8.1x OCF.
- By combining its expected OCF growth rates with its normalized valuation, we get a fair price target of roughly $46, which is 17% above the current price. However, I see more upside, as high-quality MLPs like Enterprise Products Partners (EPD) have normalized OCF multiples north of 10.
- Hence, I would make the case that MPLX is trading at least 20-25% below its “fair” value.
- When including its dividend/distribution, the stock has a 16% annual return potential through 2026. However, please note that this is a purely theoretical number. Economic headwinds could pressure this return going forward.
Having said all of this, despite its strong recent performance, I believe MPLX still offers a lot of long-term shareholder value.
In fact, it may be my favorite 9%-yielder on the market right now!
Takeaway
If you’re seeking a combination of elevated income and growth potential, the midstream industry may be right for you.
MPLX, with its strategic positioning and steady performance, stands out as a promising high-yield play.
With consistent dividend growth and undervalued equity, it’s a compelling investment for long-term investors seeking income with upside potential.
Pros & Cons
Pros:
- Robust Income: MPLX offers a juicy dividend yield of 8.6%, providing investors with a steady stream of income.
- Steady Growth: With a five-year dividend CAGR of 5% and a track record of consistent performance, MPLX demonstrates the potential for long-term growth in shareholder returns.
- Strategic Positioning: Backed by a strong partnership with Marathon Petroleum and a significant market presence, MPLX benefits from stable cash flows and growth opportunities in key basins like the Marcellus and Permian.
- Balanced Financials: MPLX maintains a healthy balance sheet with an investment-grade credit rating.
Cons:
- Regulatory Risks: The energy industry is subject to regulations, which could affect MPLX’s operations and profitability.
- Dependency on Oil and Gas Markets: MPLX’s performance is closely tied to the demand for oil and gas products. Economic downturns could pressure demand for fossil fuels.