More than 10 months into 2021, it’s safe to say that plenty of investors are aware of the fact that energy is the best-performing sector in the S&P 500.
Midstream and energy infrastructure assets aren’t just getting in on the act. They’re displaying leadership qualities. Check out the Alerian Energy Infrastructure ETF (ENFR), which is higher by 43.34% year-to-date and flirting with all-time highs.
A big selling point with midstream and energy infrastructure assets is income — much more than is found in the traditional energy sector. ENFR answers that bell with a dividend yield of 5.62%, or more than quadruple what investors earn on the S&P 500. However, big dividends need to be supported by cash, and there have been times in the energy sector when high dividend names were forced to cut payouts. Fortunately, midstream’s free cash prospects look as strong as they have in years.
“Across the energy sector, free cash flow (FCF) generation is a priority as companies look to lure back investors by enhancing shareholder returns through dividends and buybacks,” says Alerian analyst Stacey Morris. “For many companies, a past emphasis on growth has been replaced by a focus on capital discipline and efficiency. Specific to midstream, years of hefty investments to facilitate the boom in US energy production have largely given way to more modest spending plans, which is allowing for FCF generation even after accounting for generous dividends.”
Midstream operators, including ENFR components, support robust FCF thanks to long-term agreements with clients, but there’s more to the story. Importantly, midstream companies, realizing the energy industry is changing and that opportunities for new large-scale projects are scant, are dialing back capital spending.
“From a spending perspective, instead of building massive new pipelines, companies are mostly pursuing bolt-on projects, joint ventures with modest capital requirements, and/or smaller expansions, which is more in line with what is needed today given the current US production outlook. The absolute improvement and positive trend in FCF yield for midstream screens favorably when compared to the broader market and utilities,” adds Morris.
This transformation is positive because the renewed emphasis on FCF among midstream operators could signal to investors that this category is home to increasingly durable and reliable dividends, which is exactly what long-term investors are looking for.
For more news, information, and strategy, visit the Energy Infrastructure Channel.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.