Nothing like having Goldman Sachs (NYSE: GS) confirm what we've already been saying for a year.
But last week, Goldman Sachs reminded us that they are bullish on the oil and gas pipeline sector by upgrading a number of portfolio stocks that have been prominent features of our portfolios and discussion on the sector.
Goldman analysts made headlines last week by adding a number of pipeline firms to their "Conviction Buy" list. The company added Williams Companies (NYSE: WMB) while dropping Buckeye Partners L.P. Nonetheless, Goldman still rates Buckeye as a "Buy."
Goldman also raised a number of additional stocks to the buy list, including Plains All American Pipeline LP (NYSE: PAA), and maintained its "Buy" ratings on Enterprise Products Partners (NYSE: EPD), and Enduro Royalty Trust (NYSE: NDRO), and Magellan Midstream Partners (NYSE: MMP).
The reason for these moves shouldn't be a surprise to anyone who follows us at Oil and Energy Investor.
The Sweet Spot in Oil and Gas Pipeline CompaniesIt's not surprising that Goldman Sachs is so bullish on the pipeline industry. After all, my colleague Dr. Kent Moors has been touting the best known secret on the markets for more than a year.
If you want to make money in energy investing, you want to park yourself right in the middle of the supply chain. By doing so, you're far less susceptible to price fluctuations in the underlying commodity, and you are able to collect easy profits from the growing demand in fuels.
Midstream companies, those that connect the upstream exploration and production companies to the downstream retail, refining and marketing channels, provide vital services in transportation, storage, and processing.
Simply put, this is the "Sweet Spot" of energy investing.
Midstream Master Limited Partnership operations in particular generate fee-based revenues on fuel volumes going through the pipeline. These companies enjoy less exposure to price volatility - a very welcome sign to the risk-averse investor.
And it's these partnerships that typically pay higher yields in the form of distributions to shareholders and offer the ever-tantalizing share appreciation opportunities.
Of course choosing the right MLP is always a difficult challenge, even if you're a Goldman analyst. But, just a few months ago, I wrote at length about the best way to make that decision.
And it's one that Goldman used in its own analysis before making its recent recommendations.
Distributable Cash Flows InsteadGoldman Sachs conducted thorough analysis of each company's potential to transport oil and gas liquids through their network of midstream services. Volume is always an important metric, as is the proximity to the ever-expanding shale fields across the United States.
But the reality is, the ability to simply transfer or store oil and gas is not enough to justify the purchase of shares in any of these midstream companies.
There's an important metric you need to keep your eye on. Cash flow.
Cash flow is the most important measurement of how to analyze MLPs or other midstream companies to obtain the best distribution returns.
Many of these companies have very strong yields and pay them out in the form of quarterly distributions to shareholders. These distribution payments must be funded by the companies' cash on hand. We don't want to see that they are taking on new levels of debt in order to do so.
Not only will that impact the reliability of the distribution levels, it can also greatly impact the share price.
By paying attention to cash flows, you're able to accurately measure how a company can account pipeline depreciation or other ways that the partnership reduces its tax burden and pass profits along to investors.
And those profits are what we really care about at the end of the day.
But remember, the MLP will not pay out all of its cash distributions at once. It's necessary for these partnerships to retain some of their resources. Management may need to expand operations or ensure that it can continue to pay its distributions at the same yield level in the future (or even raise them).
And a strong history of increasing yields and the company being able to meet its dividend obligations should be a signal of good things to come.
Midstream MLPs remain a major advantage for the income-seeking investor.
And if we know the best ways to measure their potential, that's even better.
Just one note: You'll want the yield to remain in or close to double digits.
Goldman Sachs is telling us what we already knew. But there's nothing wrong with that. It's good to know that one of the world's smartest banks has taken such a keen interest in the oil and gas pipeline sector along with us.
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