Pipe
Bullish themes converging Behind pipeline Stocks.
At a time that financial markets are increasingly distorted through central bank intervention — thus creating a low-yielding environment — there is a strong case to be made for seeking out real assets, especially those with reliable income streams. One option we think deserves a look, especially given that our proprietary models have a constructive view on the energy sector of late, are the pipeline stocks — both in the united States and Canada.
The overall sector was a beneficiary from the reopening trade that began late last year and has received an added boost recently from the Saudis having drawn a line in the sand on the price of oil. But, with risks abounding in the “return to normal” from the pandemic, having pipeline exposure insulates investors from the ups and downs we expect along the way, given their lower-risk business models thanks to long-term contracts, which make them less subjected to cyclical fluctuations.
We still believe there are longer-term investment opportunities surrounding climate change, but the reality is that the transition to clean energy will not happen overnight, meaning the transportation of fossil fuels is still required. Furthermore, there could even be an unintended benefit for pipeline companies insofar as the proliferation of renewable energy in the future will require the need for natural gas plants as a backup, requiring transportation, until reliable energy storage technology comes to market.
Moving from the macro to the markets, investors buying at current levels can still benefit from historically cheap valuations and lofty dividend yields — despite the S&P 500 and TSX oil and gas storage and transportation sectors rebounding 104 per cent and 35 per cent, respectively, from their 2020 lows (both remain some 25-per-cent below their pre-pandemic peaks).
Forward P/E ratios for the u.s. pipeline sector, at 17.1x, remain nearly six points lower than its five-year average while the Canadian comparable, at 15.3x, is three points below its recent norm. Not to mention that the five-point discount to the overall S&P 500 in the case of u.s. pipelines, and the 1.5-point discount to the TSX for Canadian peers sit just shy of the lowest on record — normally, the former trades at a six-point premium, while the latter typically trades nearly five points above the market multiple.
Even if relative valuations only revert to half their historical norms, that would still represent an upside of 20 to 30 per cent from these levels. All in, it is safe to say that these stocks have rarely been cheaper.
Additionally, pipeline stocks are extremely attractive from a dividend standpoint. After all, government bonds yield next to nothing, so the seven-per-cent dividend yields on S&P 500 and TSX oil and gas transportation companies look very attractive. The contractual nature of their business models means that these dividends are relatively secure. historically speaking, yields of these magnitudes are nearly unheard of — ranking in the 97th percentile of prior readings in Canada, and the 93rd percentile for the u.s.
We continue to believe that income-producing real assets offer significant benefits within a portfolio in the current economic backdrop and low interest rate environment. Given that the overall energy sector has been positively re-rated of late, u.s. and Canadian pipelines are one example of real assets that offer reliable cash flow streams that can still be bought at attractive valuation levels.
Longer-term trends toward clean energy are underway, but the world will still continue to rely on fossil fuels, so the need to transport oil and natural gas remains in place. ultimately, the combination of income and potential for price appreciation means that these stocks deserve a strong consideration in investors’ portfolios.
require the need for natural gas plants as a backup.