Midstream Players Trim Fat from Ledgers, Enter Lean Bulk Era

I’ve always been into exercise, but around 12 years ago, I started to get much more into it. Not a coincidence that it was around the time volatility in MLPs and midstream stocks ramped up. The oil and stock markets felt so out of control, I sought something I could control. Lifting weights was the answer.

I began watching YouTube videos about diet, training and equipment. I built a garage gym that became my sanctuary. I learned a ton about nutrition, strength training programming, exercise selection and technique. Two main learnings remind me of midstream stocks today.

• Growing muscle cannot generally happen while also losing bodyfat, outside of your first few months of training or if you use steroids or similar. Another exception is when coming back from a long time away from lifting weights, so recreating the newbie phase.

• Dirty bulks are usually a waste of time. Bulking to some extent is necessary, but bulking aggressively to a point where bodyfat exceeds 20% is usually not productive and just leads to a longer period of dieting to expose the gains you’ve made.

Transposing that into the midstream space, it is possible to grow EBITDA while de-leveraging and buying back stock, but it usually happens after a big dividend cut or resetting of expectations (see Targa Resources and Energy Transfer).

Leverage is like body fat: too much and you get into trouble.

On the other hand, midstream companies have found that once spending gets reined in enough, there is a point where the lack of growth becomes an issue. Midstream companies have started to eat (spend capex) again, but the gains (EBITDA growth) are lean, and they are not adding too much fat (leverage) in the process. So, midstream is growing capex again, and the market is taking a more positive view on growth capex because it is being done reasonably. Midstream is in a lean bulk phase.

Companies with the biggest capex guidance in 2025

With 2025 guidance season largely complete, it is clear that growth capex is going up. In aggregate, the 10 largest midstream companies in North America are expected to spend around 15% more in growth capex in 2025 versus 2024.

The combination of growth capital spending, M&A and true organic growth in volumes is driving accelerated EBITDA growth in 2025, as well. These 10 midstream companies are expected to see more than 7% EBITDA growth in 2025, up from 3.4% in 2023. The cumulative impact of steady growth capital spending in the last few years is driving better EBITDA growth.

Illustrative midstream business model

Midstream companies that have free cash flow to deploy will benefit over time from having high-return projects to develop. To illustrate how that midstream business model could work today, I made a basic model for a hypothetical large midstream company—let’s call it HHLP—and how it grows over 10 years.

HHLP has $5 billion of base EBITDA that grows 2.5% annually. HHLP invests $1 billion annually into projects that return 6x EBITDA in the following year, while investing 15% of EBITDA in maintenance capital. The company has a starting point leverage of 3.5x, paying interest at 5%. The stock is yielding 6% and trades at 11x EBITDA.

Taking those variables into account and assuming no multiple expansion, the business sees EBITDA growth of 5.5%, dividend growth of 9% (assuming free cash flow directed at dividends), and annual stock price total returns of 13.5%. That 13.5% return comes from the combination of dividends and dividend growth.

Key variables in the equation have improved for midstream in the last few years. First, the base business is no longer seen as a melting ice cube. The intense ESG focus has abated and natural gas is acknowledged as critical in the future.

That declining outlook from a few years ago has shifted to a base business that you could model out at 2%-3% growth from economic activity and demand over time. We’ve observed some examples of individual midstream companies that had declining base EBITDA see declines slow and improve, with re-contracting at Kinder Morgan and Plains All American Pipelines weighing less year over year.

Second, the investment opportunity set has grown, especially for larger midstream companies with opportunities across their large asset bases. It is now reasonable to assume that a $50 billion midstream company could source $1 billion of growth projects every year.

And because there are fewer large peers remaining and there are network effects of these scale companies, it is also reasonable to assume midstream companies could generate attractive returns in the 5x-7x EBITDA range on those identified investment opportunities.

Absent those investment opportunities, the base operations of HHLP would still produce decent returns. Even at 2.5% EBITDA growth and no investment in growth capital, HHLP would be able to grow dividends at more than 6% annually, still driving a double-digit annual return, assuming no change in valuation.

The base business case

I submit that the hype around growth projects is overblown relative to the starting point midstream has worked hard to achieve. The secret sauce of making the model work is the combination of starting with positive free cash flow and assuming base business grows with the economy. Layering in growth projects related to natural gas load growth is just icing on the cake that adds a few hundred basis points to annual growth.

The midstream indexes have produced stellar returns for four straight years. A four-year streak of 20%+ returns like we’ve seen has never happened to MLPs before. After such an exceptional run for the group, what is the bull case from here? Fewer, stronger companies with assets no longer in decline, plus a growing set of high-return investment opportunities.