Midstream Energy equities have continued to rally with the start of the year, and we like the setup for the group in ’21 for a number of reasons.
Midstream Energy equities have continued to rally with the start of the year, and we like the setup for the group in ’21 for a number of reasons. For one, certain key investment headwinds for the group are now squarely behind us, namely seasonal tax loss selling and the recent elections. As we went through 2020, sentiment for the broader Energy group and Midstream was at rock bottom levels (COVID, plunging commodity prices, the Clean Energy trading theme, political uncertainty, etc.), but as we’ve seen in recent months it doesn’t take much to dramatically change/boost the narrative. The vaccine approvals and deployment have done just that. We expect the economy to continue to strengthen, focusing investor attention on cyclical stocks and companies that benefit from the recovery, like Energy. Additionally, just recently, OPEC boosted market sentiment with the favorable decision to reduce production, firming up crude oil pricing to back over $50/bbl (not seen since early ’20). Then, with the Georgia Senate election runoff complete, the market has clearly embraced the idea of a still fairly divided government but with the added likelihood of much more economic stimulus, which is further fueling the rally with cyclicals (including Energy/Midstream).
With outsized and sustainable yields in an very low rate world, we believe there is much room to run for Midstream equities as they are well below pre-Covid levels while at the same time the debt market has already fully recovered. And while valuation alone isn’t a catalyst, most of our companies are generating Free Cash Flow (FCF) after dividends in 2021, and many will be in a position to buyback stock as deleveraging continues on its downward glide path. With capex spending significantly down so much already (and expected to be further reduced in ’21 and ’22), and assets in many basins underutilized, we should see operating leverage kick in as well. While there may be some political/regulatory pressure on the margin (eg Keystone XL), this isn’t anything new and we don’t think it will be as impactful or relevant to Midstream given most of the large infrastructure newbuilds are already complete or wrapping up. With regard to Clean Energy, we expect management teams to continue to explore the opportunities to participate in the multi-decade transition—particularly those with extensive natural gas pipeline infrastructure networks (which would be physically complementary with hydrogen, as an example).
Following a challenging 2020, investors have turned their attention to the Energy sector, and we believe they will be rewarded. Please reach out to us to discuss these companies, the market, and our investment products/strategies.
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