Summary
- Energy infrastructure ETFs that include corporations and MLPs tend to be appealing for their total return potential, while providing better representation of the North American midstream universe.
- Midstream yields are generous relative to other equity income investments and are backed by positive dividend trends.
- Energy infrastructure ETFs can provide purer midstream exposure today than in the past when utilities often had to round out portfolios.
Today marks the 10-year anniversary of the Alerian Energy Infrastructure ETF (ENFR). The energy infrastructure space has evolved over the last decade, as has the ETF and its underlying index. However, the appeal of diversified midstream exposure and the potential for total return remains intact. This note revisits the midstream investment case and discusses a key change in the midstream landscape over the last decade.
ENFR’s Underlying Index Provides Diversified Midstream Exposure
The Alerian Midstream Energy Select Index (AMEI), which underlies ENFR, is a composite of North American midstream energy infrastructure companies, including MLPs and U.S. and Canadian corporations. MLPs are capped at 25%, which aligns with requirements for regulated investment companies or RICs (read more). Canadian corporations currently represent almost a quarter of the index by weighting. These include familiar names Enbridge (ENB CN) and TC Energy (TRP CN). U.S. corporations round out the index, with ONEOK (OKE), Cheniere (LNG), Williams (WMB), and Kinder Morgan (KMI) among the top 10 constituents.
The Midstream Investment Case
Energy infrastructure ETFs that include corporations and MLPs tend to be appealing for their total return potential. Companies provide healthy dividends supported by fee-based business models and stable cash flows. Because of these fee-based businesses, midstream also tends to be more insulated from commodity price volatility than other energy subsectors. Midstream’s moderate correlations with other income investments can provide diversification benefits. Importantly, AMEI constituents provide critical services that ultimately connect energy production with demand in North America and abroad.
Midstream yields are generous relative to other equity income investments and are backed by positive dividend trends. As of October 26, AMEI was yielding 6.4% compared to its 10-year average of 5.8%. Based on dividends paid in 3Q23, 90.0% of AMEI by weighting have grown their dividends over the last year — with many increases outpacing inflation (read more). There has not been a dividend cut for an AMEI constituent since July 2021.
Dividend growth and equity buybacks have been supported by widespread free cash flow generation in this space (read more). As of October 26, 63.6% of AMEI had a buyback authorization. In 2023, corporations have been more active with stock repurchases than their MLP peers (read more).
While inflation and rising interest rates have been headwinds for some income investments, midstream has been resilient. Midstream tends to do well in periods of elevated inflation given real asset and energy exposure. Additionally, energy infrastructure companies typically provide services under long-term contracts with annual inflation adjustments. Midstream may be more insulated from rising rates given yields still above corporate bond benchmarks and efforts by companies to reduce debt over recent years. AMEI is up over 30% on a total-return basis from year-end 2021 to October 26, 2023, while REITs, utilities, bonds, and the S&P 500 are all down during that period.
Despite solid performance, AMEI has not become expensive relative to historical valuations. As of October 26, AMEI was trading at a 9.2x EV/EBITDA multiple based on 2024 consensus estimates and using a weighted average. This represents a discount to its three-year average forward EV/EBITDA multiple of 9.8x.
AMEI Has Adapted With the Midstream Universe
At the launch of the ETF in 2013, the underlying index included 30 core U.S. and Canadian energy infrastructure names divided among five categories, including a 25% weight to MLPs. The 25% weight to MLPs and 75% to corporations has been constant given the RIC-compliant nature of the ETF. However, 10 years ago, utilities were necessary to round out the 75% exposure to corporations as the midstream landscape was dominated by MLPs.
Utilities that owned a general partner interest in an MLP were included in the index up until mid-2018. At that point, there were enough U.S. and Canadian midstream corporations to allow for purer midstream exposure (read more). Today, U.S. and Canadian corporations account for roughly 60% of the total North American energy infrastructure market capitalization. Interestingly, some popular energy infrastructure ETFs maintain significant weightings in utilities today, which tends to result in lower yield and has been a drag on performance in 2023 (read more).
Beyond the potential for total return, midstream investments with corporations and MLPs are likely to appeal to investors who want greater diversification. Corporations have also been more proactive with clean energy initiatives and typically have more exposure to long-haul natural gas pipelines. These factors may also add to the attraction of RIC-compliant energy infrastructure ETFs.
Bottom Line:
Energy infrastructure ETFs that include corporations and MLPs tend to be appealing for their total return potential, while providing better representation of the North American midstream universe.
To learn more about midstream from a constituent company, join our 30-minute LiveCast on Tuesday, November 7, at 12:30 p.m. ET: “Midstream/MLP Spotlight: Plains All American (PAA/PAGP). Register here.
AMEI is the underlying index for the Alerian Energy Infrastructure ETF (ENFR) and the ALPS │Alerian Energy Infrastructure Portfolio (ALEFX).
Related Research:
RICs, ETNs, and Picking the Right MLP Investment
Examining Midstream/MLP Dividend Growth by Company
Midstream Sees Strong Free Cash Flow Generation in 2023
Midstream Buybacks Picked Up in 2Q23
Midstream/MLPs vs. Utilities: Key Investment Differences
Midstream/MLP M&A Update: Parent Buy-Ins and More
For more news, information, and analysis, visit the Energy Infrastructure Channel.
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