Research report

Energy infrastructure: Valuations low, fundamentals sound

Why midstream may be an attractive space in today’s expensive market.

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September 9, 2020 | 7 minute read

As the COVID-19 crisis has battered global energy demand and oil prices, the midstream energy sector is one area that has remained resilient, thanks in large part to its steady cash flow profile. Valuations in the space, however, remain extremely depressed. We look at those valuations, how they have decoupled from fundamentals, and why we believe midstream may be an attractive space in the current market.  

Possibly the most confusing and essential question facing investors in 2020 is what to make of current equity market valuations. Some commentators have called the market a bubble akin to the one that burst in 2001, while others have cited deeply negative real interest rates, an acceleration of a tech-dominated future, and massive Fed liquidity as a justification for sky-high valuations. Whatever the reason, the reality remains that valuations are historically high, and long-term equity returns have consistently been negatively correlated with starting valuations.

The good news for investors is that there are areas of the stock market that continue to show attractive valuation relative to history and the market. While some sectors trade at low multiples for good reason, we believe there are areas of opportunity in today’s market. One area that remains compelling in an otherwise expensive market is midstream energy, or energy infrastructure.

Weak returns have followed expensive market valuations

Source: Bloomberg Finance, L.P., as of August 31, 2020.

Key takeaways
  • Investors are faced with extremely high public equity valuations, a reality that has historically resulted in lower long-term forward returns.
  • In contrast, valuations in the energy infrastructure space are near record lows.
  • Midstream fundamentals remain solid, with Q2 earnings results showing the resiliency of the sector.
  • High current income could be supplemented by capital appreciation as valuation improves with greater free cash flow, reduced leverage, and increased shareholder returns.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

Robert Hoffman, CFA

Managing Director, Investment Research

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