The ALPS Alerian MLP ETF (NYSEArca: AMLP), the largest exchange traded fund focusing on master limited partnerships, sports a dividend yield of 7.72% as of Oct. 22.
Alone, that’s enough to grab investors’ attention, particularly at a time when AMLP’s yield is more than six times what investors earn on 10-year Treasury yields. On the other hand, some investors, no matter how hungry for income they are, don’t want to embrace frothy valuations, which are often hallmarks of high dividend stocks.
Fortunately, the broader energy sector is still attractively valued despite its status as the best-performing group in the S&P 500 this year, and that valuation status applies to pipeline operators, including some AMLP components.
“For investors looking for a combination of high dividend yields and undervaluation, the pipeline sector has several to choose from. However, investors need to understand that the price movement on these stocks may be more muted in the near term,” says Morningstar analyst Dave Sekera.
While rising oil prices are helping integrated oil and exploration and production stocks, and some analysts believe that there’s more to come in those industries, MLPs usually aren’t dependent on oil prices to drive returns. Rather, AMLP components benefit from rising volumes, which come about when demand is brisk.
“For pipeline companies, volumes are more important than prices, and with many U.S. producers pledging to hold volumes relatively flat and live within cash flows in the short term, pipelines aren’t necessarily seeing the same expected volume uplift in the near term that they would have in cycles past,” adds Sekera.
Among the midstream companies Morningstar considers undervalued are Plains All American Pipeline LP (NYSE:PAA) and Enterprise Products Partners (NYSE:EPD). Those are AMLP’s largest and third-largest holdings, respectively, combining for 20% of the fund’s weight. Energy Transfer (NYSE:ET) also earns the undervalued label from Morningstar. That stock accounts for 9.5% of the AMLP roster. Put it all together, and AMLP offers a surprising amount of value with an impressive income stream.
“In a market that we consider to be broadly trading on the high side of our fair value range, the energy sector is one of the few areas we continue to view as undervalued. While the undervaluation has declined as the stocks have ramped higher over the past few weeks, we continue to see more 4- and 5-star stocks in this sector than any other,” concludes Sekera.
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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.