Last week, analysts at Credit Suisse unveiled their view on a whole host of energy stocks. While they were bullish a large portion of the sector, they saw the most upside in the following three high-yield stocks:
Here's a look at why this trio could outperform in 2018.
Several catalysts on the horizon
Energy Transfer Equity is coming off a tough 2017, when it lost 10.6% of its value. That's not all that surprising, since distributable cash flow through the third quarter was $726 million, which was down 20% versus the year-ago period. The company therefore distributed more cash to investors than it brought in, with its coverage ratio falling to a concerning 0.96 through the third quarter.
However, this decline is a bit deceiving, since the driver was an increase in the amount of incentive distribution rights (IDRs) from its master limited partnership (MLP), Energy Transfer Partners (NYSE: ETP), that it agreed to relinquish. Energy Transfer Equity did so to help support its namesake MLP as it works through a massive expansion phase. If we back out that support, then cash flow would have increased 3.3%.
Either way, 2018 should be a bounce-back year for the company. First of all, the IDR support will wane, with Energy Transfer Equity only relinquishing $153 million in IDRs this year after forfeiting $655.5 million last year. On top of that, Energy Transfer Partners' expansion efforts are starting to pay dividends, which means even more cash will flow to Energy Transfer Equity via the IDRs. Finally, the company's other MLP, Sunoco LP (NYSE: SU), is in the process of selling the bulk of its gas stations. Once that deal closes, it will improve Sunoco LP's financial situation, enabling it to redeem the $300 million preferred stock investment Energy Transfer Equity made last year to help keep it afloat. That looming redemption could provide Energy Transfer Equity with the cash to repurchase its cheaper units. As these catalysts come to fruition, they could provide Energy Transfer Equity with enough fuel to hit Credit Suisse's price target.
Dirt-cheap with catalysts, too
Kinder Morgan also lost value last year, falling 12.7% even though it completed its turnaround plan and cash flow was flat with 2016. The stock therefore currently trades for a ridiculously cheap valuation of 8.8 times cash flow, which is well below the 14.9 average of its peer group.
Any of several catalysts could push Kinder Morgan's valuation closer to that peer average. For starters, the company expects to boost its dividend 60% this year, which would move its yield closer to 4.4%, making it much more enticing to income investors. In addition to that, the company could buy back up to $500 million of its cheap stock this year, which could also provide a nudge. Finally, the pipeline giant has been weighed down by a delay in starting construction of its massive Trans Mountain Pipeline expansion project. However, it recently won a key court battle, which could finally enable the company to move forward with this crucial project. The potential upside from these catalysts is why Credit Suisse' analysts aren't the only ones bullish on Kinder Morgan's stock.
Growth coming down the pipeline
Western Gas Equity, which owns the IDRs of Western Gas Partners (NYSE: WES), also slumped last year, falling 12.3%. That decline came even though the company raised its distribution to investors by 20% over the past year, thanks to an increase in the IDRs it receives from Western Gas Partners.
That growth should continue this year. Western Gas Partners expects to invest between $1 billion and $1.1 billion on expansion projects, which should fuel 14% per earnings growth, enabling the company to increase its distribution to investors by 7%. A portion of that growing income stream will head to Western Gas Equity, giving it the money to boost its payout another 12% this year. The rising cash distributions alone should help drive Western Gas Equity's valuation higher this year.
The formula to outperform
All three of these energy stocks have two things in common. First, each lost value last year even though their underlying businesses held up just fine. Meanwhile, they all have visible growth on the horizon, which should enable them to send more money to investors in 2018. That combination gives them plenty of fuel to potentially outperform their peers this year. On top of that, they all pay a high-yield dividend, which means investors could earn an even higher total return from this trio in 2018.
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Matthew DiLallo owns shares of Kinder Morgan and has the following options: long January 2018 $30 calls on Kinder Morgan and short March 2018 $17 puts on Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool has a disclosure policy.