The midstream energy companies, such as NuStar, will benefit from rising prices, according to Wells Fargo.
Inflation is generally a bad thing, as you already know from your visits to the grocery store. Price increases erode your purchasing power and create imbalances in the economy.
That’s why the Federal Reserve is willing to risk a recession by raising interest rates to get inflation back under control. Consumer prices soared 8.3% in the 12 months through April.
But there’s a silver lining to the inflation cloud. It’s a “net positive” for midstream oil and gas companies, Wells Fargo analysts wrote in a commentary.
“Most midstream companies have built in contractual escalators tied to inflation,” the analysts said. That means the companies’ customers have to pay higher prices when inflation rises.
And while they’re benefiting from these escalators, most midstream companies are controlling costs, the analysts said. “Thus, we’d expect base business cash flows for most midstream operators to surprise to the upside in 2022,” they said.
“This should more than offset any potential headwinds from higher interest rates.”
Rising rates make borrowing more expensive for midstream (and other) companies. Higher rates also make the dividends paid by midstream companies less attractive compared with the rising rates paid by bonds.
The analysts said large-cap midstream companies with the biggest exposure to inflation include:
Wells Fargo: NuStar Upgrade
Wells Fargo analysts upgraded NuStar to overweight from equal weight May 31.
“NuStar is another play on inflation, with 95% of its pipeline under [government-]regulated tariffs subject to a producer-price index adjuster,” they said. That means “any reduction in refined product volumes due to demand destruction should be offset by inflation protection.”
Also, “the partnership’s Permian gathering assets continue to grow, and the recent initiative to reduce costs and capital expenses by $50 million should improve margins,” the analysts said.
“NuStar’s significant presence in the California renewable fuels market should continue to yield low cost, high return projects.” In addition, NuStar’s stock has underperformed its peers this year, the analysts noted.
They raised their price target on the company’s shares to $18 from $17, compared with a recent quote of $16.53.
Morningstar on Enterprise Products
Morningstar analyst Stephen Ellis assigns a wide moat to Enterprise Products and puts fair value for the stock at $27.50, compared with a recent quote of $28.11.
“Enterprise Products Partners’ first-quarter results were good, as the firm benefited from its recent leaning-in to commodity price tailwinds with the [$3.25 billion] acquisition of Navitas Midstream,” he wrote in a commentary.
“We think the timing of the Navitas deal [completed Feb. 17] was excellent, as we expect very healthy near-term oil and gas prices, a key factor driving results,” Ellis said.
The author of this story owns shares of Enterprise Products and Enbridge.