ET - EMLP: High Yield Distribution Amidst Falling Oil Prices

2023-11-08 11:40:28 ET

Summary

• EMLP is an active ETF focusing on North American energy infrastructure, targeting stable cash flows from its holdings.
• While strong demand for oil and gas boosted the ETF's performance in recent years, oil price volatility remains a risk going forward.
• Although EMLP offers a high distribution yield, its expense ratio is relatively high compared to alternative funds.

Overview

The First Trust North American Energy Infrastructure Fund ( EMLP ) is an actively managed exchange-traded fund (ETF) that primarily invests in North American energy infrastructure companies, including those involved in the pipeline, midstream, and electric power sectors. Its portfolio consists of a mix of master limited partnerships (MLPs), MLP affiliates, utilities, and pipeline companies.

The ETF aims to provide investors with a combination of income, growth, and diversification by investing in energy infrastructure companies, which are expected to have relatively stable cash flows because of their involvement in energy transportation, storage, and processing. These companies may benefit from the demand for energy infrastructure that is less sensitive to commodity price fluctuations.

EMLP typically focuses on companies that may have the potential to pay out attractive dividends or distributions, which is why it can be appealing to income-focused investors. Here, the ETF has a distribution yield of 4.03%, representing the annual paid-out dividends. However, the ETF has a relatively high expense ratio of 0.95%, which represents the annual management costs when investing in the ETF. The fund has assets under management ((AUM)) totaling $2.3 billion.

Holdings & Valuations:

The top holdings of the EMLP ETF include Enterprise Products Partners L.P. ( EPD ) with a weight of 7.80%. Enterprise Products Partners is engaged in the energy infrastructure sector, specifically in the midstream energy business. They operate a network of pipelines, storage facilities, and processing plants to transport and process natural gas, crude oil, and other petroleum products.

Energy Transfer LP ( ET ) is another significant holding with a weight of 6.79%. The company is involved in the transportation and storage of natural gas, crude oil, and refined products. They own and operate a vast network of pipelines, terminals, and storage facilities.

Plains GP Holdings, L.P. ( PAGP ) makes up the third largest holding with a weight of 6.06%. Plains GP Holdings is a holding company that owns an interest in Plains All American Pipeline, L.P., an energy infrastructure company involved in the transportation, storage, and marketing of crude oil, natural gas liquids, and other related products.

Overall, the ETF focuses on mid-cap companies in the energy sector, with an average weighted market cap. of $28 billion. The ETF is well diversified with over 64 holdings, as of the latest update. EMLP has the majority of its investments concentrated in North American companies, with a dominant 87.72% allocation in the United States and 6.57% in Canada. These investments are primarily entities involved in energy infrastructure such as pipelines, utilities, and storage operations. The rest of the fund's portfolio includes diversified but smaller positions in countries such as Italy and Spain, each constituting roughly 0.7% of the allocation.

The ETF's valuation appears quite moderate at a Price/Earnings (P/E) Ratio of 15.98 and a Price/Book (P/B) Ratio of 1.97. This compares to the S&P 500 ( SPY ), which has an average P/E ratio of 21.4 and a P/B ratio of 3.99. However, it should be noted that technology companies such as Microsoft ( MSFT ) and Nvidia ( NVDA ) hold higher valuations, yet also boast higher profit margins than many companies in EMLP. Thus, their higher valuations likely account for higher earnings growth in the future.

Nevertheless, many top holdings in EMLP are attractively valued on an earnings basis. Here, Enterprise Products Partners and Energy Transfer trade at just 10 times Price to earnings. However, it should be noted that the earnings of EMLP's holdings are highly correlated with oil prices, which have surged as a result of a sharp and robust global economic recovery after the Covid pandemic, coupled with increased demand for oil and gas. Nevertheless, oil prices have recently dropped to their lowest levels since August as data from China sparked demand concerns.

Consequently, if oil prices stabilize or decline as the economy shifts, future earnings for these companies might decrease, potentially leading to a rerating of their market valuations.

Performance:

As oil prices dropped 13% year-over-year, holdings in EMLP saw revenues decline from last year. As a result, the ETF has only returned 4.5% year-over-year (YoY), including its 4% dividend. Therefore, it significantly underperformed the S&P 500, which benefitted from the performance of technology giants Microsoft, Nvidia, and Meta Platforms ( META ). It also underperformed alternative energy fund Alerian MLP ETF ( AMLP ) , which shares some of the same holdings , yet placed a higher weight on well-performing stocks such as Plains GP Holdings with a weight of over 14%. Overall, AMLP is much more concentrated with only 15 holdings. Its expense ratio is comparable at 0.87%, yet it boasts a higher distribution yield at 7.7%.

However, EMLP outperformed the iShares U.S. Energy ETF ( IYE ) by a wide margin. The ETF covers the energy segment of the US large-caps, such as Exxon Mobil ( XOM ) and Chevron Corporation ( CVX ). Since large-cap energy stocks underperformed over the past year, with Chevron down 22% YoY, dragging down the entire ETF. IYE has a smaller expense ratio of just 0.4%, yet also a lower distribution yield at 3.1%.

Takeaways:

While EMLP presents a steady income opportunity from the mid-cap energy sector in the U.S., its relatively higher expense ratio makes it less appealing compared to alternatives such as the Global X MLP & Energy Infrastructure ETF ( MLPX ) or the Energy Select Sector SPDR Fund ( XLE ), in my opinion.

Both MLPX and XLE are known for offering high dividend yields, which can be attractive for income-seeking investors. Nonetheless, the performance of these ETFs, including EMLP, is highly dependent on oil prices. These prices have been particularly volatile recently, reflecting the uncertain economic landscape. The volatility in oil prices stands as the primary risk for EMLP and similar ETFs, posing potential risks to their performance in the future.

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