Over the past few years, as equity markets have pushed higher and valuation multiples have expanded, one sector has continued to appear to offer value. The oil and gas midstream sector sometimes looks to be one of those parts of the market that investors generally overlook.
A quick glance at the sector today throws up 10 different stocks trading at a valuation of less than book value. That appears incredibly cheap in the current market environment.
Further analysis shows 22 securities with a price-to-free-cash-flow ratio of less than 10. Twenty-six different stocks in the sector are selling at a forward price-earnings ratio below 11.
In addition to the general industry-wide troubles, midstream hydrocarbon companies have some unique quirks which may put investors off from investing in the sector. For one, many of these companies operate under partnership structures, which allows them to distribute significant amounts of cash to investors. Many enterprises have abused this structure in the past. Ten years ago, partnerships, primarily pipeline partnership companies, were riding high off the back of the oil and gas boom. As a result, investors rushed to buy these stocks and their rising distribution yields. Unfortunately, many of these companies were returning too much cash and building up large amounts of debt. This resulted in an industry re-set. Distribution yields were slashed, and many companies went bankrupt when the oil and gas bubble collapsed in 2014 and 2015.
Today, parts of the sector have more assertive financial discipline, which could make them worth considering as potential investments, in my opinion. One such company is Enable Midstream Partners, LP (ENBL, Financial), which appears to be an undervalued gem.
Undervalued gem
At the time of writing, this stock is trading at a price-book ratio of 0.6, a forward price-earnings ratio of 11.3 and a price-to-free-cash-flow ratio of 12. Its distribution yield stands at 7.8%.
The stock looks cheap, but these metrics are somewhat irrelevant because the company is in the process of merging with peer Energy Transfer LP (ET, Financial). In the all-equity transaction, Enable common unitholders will receive 0.8595 Energy Transfer common units for each Enable common unit. Energy Transfer is the acquirer in this case and is expected to generate more than $100 million of annual run-rate cost and efficiency synergies when the deal is complete.
Energy Transfer's goal is to help increase cash flow and reduce debt. When the terms of the merger were announced, it stated, "The transaction furthers Energy Transfer's deleveraging efforts as it is expected to be immediately accretive to free cash flow post-distributions, have a positive impact on credit metrics and add significant fee-based cash flows from fixed-fee contracts."
Enable itself is cash generative. For the second quarter of 2021, net cash provided by operating activities was $190 million, an increase of $79 million compared to $111 million for the second quarter of 2020. Distributable cash flow of $184 million exceeded declared distributions to common unitholders by $112 million.
Energy Transfer also looks appealing. This stock is trading at a price-to-free-cash-flow ratio of 4.8 and a forward price-earnings ratio of 7.7, and it offers a distribution yield of 6.1%.
The stock is a favorite of David Abrams (Trades, Portfolio) and Leon Cooperman (Trades, Portfolio). Abrams' Abrams Capital Management owns 22 million shares, giving it a 5.2% portfolio weight. Meanwhile, Cooperman owns 6.7 million shares.
Even if the merger falls through, Enable's stock looks cheap, and the company is so cash generative that I believe the risks of investing in the business are greatly reduced. It could be worth considering this enterprise as a value and growth play as well as an income investment.
