AMLP - Warren Buffett 'Likes Pipelines' - Our Top Picks

2023-08-04 06:55:50 ET

Summary

• Pipelines fit Warren Buffett's investing philosophy quite well.
• As a result, it should not be surprising that he is pouring billions of dollars into the sector.
• We share our top pipeline picks.

Glenview Trust's CIO and Berkshire Hathaway ( BRK.A )( BRK.B ) shareholder Bill Stone recently stated :

Buffett has liked pipelines for a long time, given their toll bridge-type revenues rather than pure commodity exposure.

In this article we will explore why Warren Buffett likes pipelines so much and what some of our top picks in the sector are at the moment.

Why Warren Buffett Likes Pipelines

While Warren Buffett's recent affection for E&P energy stocks like Occidental Petroleum ( OXY ) signals his overall bullishness on energy, energy midstream infrastructure is particularly suitable for his investing philosophy. Mr. Buffett has long maintained that it is best to invest in simple businesses that are easy to understand and value. Midstream infrastructure ( AMLP ) typically fits in this category given that its cash flows are typically highly contracted with lengthy terms, enjoy protection from commodity price volatility and even in some cases these contracts have a take-or-pay nature to them whereby volumes do not even impact the fees earned from the infrastructure assets.

Moreover, there is no complicated, ever-evolving technology evolved, and pipelines often enjoy a moat if they are located strategically and in an area where it may be difficult or uneconomical for a competitor to build another pipeline. In many ways, they are like the railroads/toll roads of the energy industry, and Warren Buffett has certainly made it clear that he loves railroads given that he has billions of dollars invested in that sector already.

Given the nature of midstream infrastructure, it is not surprising then that Warren Buffett has invested billions of dollars into the sector in recent years. For example, a few years ago he plunked down ~$10 billion for a natural gas pipeline from Dominion Energy ( D ) and just recently he poured a whopping $3.3 billion into a liquefied natural gas midstream investment.

Our Top Picks

We also really like pipelines and have been buying them very aggressively. While we recently sold our position in The Williams Companies ( WMB ) as well as our position in Plains All American Pipelines ( PAA )( PAGP ) at large profits after their very strong recent outperformance, we are still significantly overweight the sector. Here are two among several of our favorite midstream picks of the moment:

#1. Enterprise Products Partners ( EPD )

EPD has a diversified and large-scale business model, with over 50,000 miles of pipelines, 260 MMBls of liquids storage capacity, 29 natural gas processing plants, 25 fractionators, and 20 deep-water docks, and a plethora of high-returning, low-risk projects set to come online in the coming months and years. Moreover, its geographic and commodity diversification, along with long-term fee-based contracts, ensures consistent and dependable cash flows and high returns on investment.

When combined with the considerable insider alignment (nearly one-third of the partnership is owned by insiders), it is unsurprising that EPD has built a long-term track record of prudent capital allocation and balance sheet management while delivering market-crushing total returns to investors:

Moreover, with a sector-best A- credit rating and a very low leverage ratio that should only go lower as more of its projects come online in the coming years, EPD is not only well protected against interest rate uncertainty and any challenges that may come its way, but also well-positioned to respond opportunistically to consolidate the industry and grow its business. If no acquisitions come to fruition, it can always use its surplus capital to buy back units and/or grow the distribution more aggressively as its leverage ratio falls in the coming years.

Last, but not least, its 7.5% current yield coupled with its expected ~5% distribution per unit CAGR for the foreseeable future, backed by its quarter-century of consecutive yearly distribution growth make it a very compelling income growth investment.

#2. TC Energy Stock ( TRP )

TRP has been a major dog recently as the market has frowned upon the disappointing valuation it got for selling a stake in some high-quality core pipeline assets (which it used to deleverage its balance sheet considerably) as well as its announced spin-off plan for its liquids pipelines business.

That said, we think it is very undervalued right now with a solid BBB-rated balance sheet and an attractive asset portfolio underpinning its value proposition. For example, most of its EBITDA comes from regulated or long-term contracted assets in strategic locations.

Moreover, while its spin-off may create some uncertainty in the market for a while and may not deliver quite the value that management projects, it is unlikely to hurt the business too much as it could unlock some additional growth opportunities and synergies for the soon-to-be-separated businesses while also dangling the liquids pipelines business in front of the market for a potential future takeover by another party.

In the meantime, TRP offers a highly compelling 8% forward dividend yield that is covered ~1.8x by distributable cash flow and should grow roughly in-line with inflation over the long-term, while cash flows should grow at an even faster rate than that as management uses the excess retained cashflow to deleverage further and fund its exciting backlog of compelling growth projects.

As a result, we find it highly likely that TRP will deliver significant total return outperformance over the long-term and hold it as one of our largest positions as a result.

Investor Takeaway

Warren Buffett has always liked simple business models that are easy to value. He also likes businesses that throw off a lot of stable, predictable cash flow. Finally, he loves businesses that enjoy a natural moat. Midstream infrastructure checks all three boxes and, as a result, Mr. Buffett has not been shy in recent years about throwing billions of dollars at the sector.

While we are not billionaires like Buffett, we are still buying midstream companies like EPD, TRP and several others aggressively to lock in the safe, high yields while prices are still attractive.

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