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The rapid growth of the cloud and AI markets is driving natural gas prices higher, since U.S. data centers get over 40% of their electricity from natural gas. That's been a boon for natural gas producers and the midstream pipeline companies that transport the gas.
But as winter approaches, natural gas prices will likely climb even higher as temperatures drop and heating costs rise. To profit from that shift, investors should consider investing $2,000 (or more) in these two top pipeline stocks: Energy Transfer (TXSE: ET) and The Williams Companies (NYSE: WMB).
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Energy Transfer operates more than 140,000 miles of pipeline across 44 states. It transports crude oil, natural gas, natural gas liquids (NGL), and other refined products through its pipelines, and exports natural gas (LNG) through its marine export terminals.
Roughly 30% of all natural gas produced in the U.S. flows through Energy Transfer's pipelines. It typically generates around 40% of its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) from its natural gas assets. That percentage will increase after it closes its $2.6 billion acquisition of Vaquero Midstream later this year.
Energy Transfer is a master limited partnership (MLP), which combines its own income with a return of capital to pay more tax-efficient distributions than regular corporations. That's why it pays a high forward yield of 6.6%. Those payments only consumed about half of its distributable cash flow (DCF) over the past few years, so it has plenty of room to raise its payout.
However, investors in MLPs must file an extra K-1 form to report that income every year. If you don't mind that extra work, it still looks like a bargain at 12 times this year's earnings per unit.
The Williams Companies operates over 32,000 miles of pipeline in 24 states. It's smaller than Energy Transfer, but it mainly transports natural gas and NGLs. It owns Transco, the largest natural gas pipeline in the U.S, which connects the Gulf Coast to the Atlantic Seaboard.
Williams transports about a third of all natural gas produced in the U.S., making it a more focused "pure play" on natural gas than Energy Transfer and many of its industry peers. Williams is also structured as a regular C-corporation rather than an MLP, which might make it more appealing to investors who don't want to deal with the extra tax paperwork.
Williams pays a forward dividend yield of 2.9%, which may seem low relative to other pipeline stocks, but its trailing payout ratio of 82% leaves plenty of room for future hikes. It isn't a screaming bargain at 27 times forward earnings, but its direct exposure to the booming natural gas market -- without the noise of crude oil -- could justify that higher valuation.
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Leo Sun has positions in Energy Transfer and Williams Companies. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
Got $2,000? 2 Natural Gas Pipeline Stocks to Buy Before Winter. was originally published by The Motley Fool
