ET - MLPX: Solid Midstream Energy Fund Balancing Income And Appreciation

2023-04-13 18:04:42 ET

Summary

• MLPX provides instant diversification across 27 of the best run midstream oil & gas companies in North America.
• Though renewables are growing rapidly, so is natural gas. Most of MLPX's commodity exposure is to gas rather than oil.
• MLPX offers an attractive 6% yield as well as steady appreciation and dividend growth.

The Global X MLP & Energy Infrastructure ETF ( MLPX ) is, in my opinion, the finest basket of midstream oil and gas companies that Wall Street has to offer.

The fund limits master limited partnerships ("MLPs," which generate a K-1 form if owned individually) to less than 25% of the fund in order to avoid fund-level taxation, which ultimately allows more dividend and distribution income to pass through to shareholders. So, MLPX shareholders get the benefit of higher pass-through income without needing to worry about K-1 forms during tax season.

Another tax benefit is the fact that investors do not need to worry about dividend tax withholding for the Canadian domiciled holdings like Enbridge ( ENB ).

MLPX is also a great, relatively low-risk way to generate steady income from the energy sector because of its long-term, mostly fixed-rate contracts that don't fluctuate with commodity prices. Moreover, pipelines, storage assets, and export terminals should be a major beneficiary of North America's significant oil and gas reserves as well as its investments in LNG exports.

Here's how I summarized the macro backdrop for North American energy in my May 2022 article on MLPX :

[T]he world needs oil & gas, North America has a lot of it in the ground, and midstream infrastructure will continue to be useful to transport, store, and export it for decades to come.

For more background information on the energy market and why North American midstream infrastructure is an ideal play on it, I commend to you that article to read as a precursor to this one.

In this article, I want to touch on midstream's role amid rapidly growing renewable energy adoption, then highlight a few critical aspects of the fund.

Renewables Vs. Fossil Fuels? Or Renewables And Fossil Fuels?

Amid the well-publicized electrification of almost everything that can be electrified (most notably vehicles), it should come as no surprise that electricity usage is increasing. This means that the "pie" of electricity generation is growing. When the pie is growing, there's more room for multiple winners who can each grab their own share of that growing pie.

This is the case for renewables and natural gas in the utility sector. The following chart highlights the rapid growth of renewables in the last decade, but notice also how fast natural gas has grown its share of electricity generation.

Since 2010, natural gas as a source of electricity has grown almost as fast as renewables and remains the largest source by a wide margin. The consistency and dispatchability of gas are an excellent complement to the low carbon intensity and irregularity of renewables.

The decline of coal is to the benefit of both renewables and natural gas. That implies more gas production, and that increased gas needs to be transported, processed, and stored in order to get to its end destination of a gas-fired power plant that generates the electricity required for you to read this article.

Besides, midstream companies are increasingly investing in renewables projects themselves. Consider, for example, Canadian midstream giant Enbridge's recent joint venture deal to develop France's largest offshore wind farm.

Best-In-Class Midstream ETF

MLPX owns a concentrated portfolio of 27 midstream energy corporations and MLPs. There are more midstream companies available to choose from, but MLPX owns the best-run, highest-quality players in the space, in my estimation.

To manage this curated portfolio, Global X charges you an expense ratio of 0.45%. That's 10 basis points higher than the 0.35% expense ratio charged by the Alerian Energy Infrastructure ETF ( ENFR ), but it should be noted that even with the higher fees, MLPX has produced better total returns than ENFR over its lifespan:

Also, as you can see, the two ETFs that diversify holdings between midstream companies organized as corporates and those organized as MLPs perform much better than the ETFs focused only on MLPs.

Moreover, the ETF has actually outperformed most of its largest holdings on a total return basis since its inception:

Admittedly, MLPX has only barely outperformed ENB, and in fact MLPX tends to trade like a slightly less volatile ENB.

One major contributor to MLPX's outperformance over most of its individual holdings is its fourth largest holding in Cheniere Energy, Inc. ( LNG ), which boasts a commanding market position in the burgeoning North American liquefied natural gas export industry and has massively outperformed in recent years.

The Russian invasion of Ukraine and subsequent European weaning off of Russian gas has been a huge boon to American LNG exports and to Cheniere Energy by extension.

It is to MLPX's benefit, in my opinion, to include not only high-yield / low-growth names but also one or two high-growth / low-yield companies like Cheniere.

It may lower the ETF's distribution yield (6.16% 30-day SEC yield as of 4/12/23), but it also marginally increases MLPX's total returns and distribution growth.

When it comes to MLPX's top holdings, it's notable that slightly over 2/3rds of net assets (67.1%) are concentrated in the top ten. All but two of these ten are organized as corporations or general partners.

Although there are some holdings like ENB and Energy Transfer LP ( ET ) that have significant oil exposure, the portfolio is mostly geared towards natural gas.

Notice below that about 43% of the portfolio's assets are directly in natural gas storage and transportation, while 34% is in oil & gas gathering and processing. Over half of this is also geared towards natural gas.

Thus, as a rough rule of thumb, we might surmise that about 2/3rds of MLPX's portfolio services natural gas with the remaining 1/3rd servicing oil. Or perhaps it's closer to 60%/40% gas to oil. In either case, MLPX is more geared towards gas than oil. I view that as a positive since demand for gas should remain steadier given its use in electricity generation as well as LNG exports.

Bottom Line

While I do own a few of MLPX's holdings individually, I am happy mostly gaining exposure to midstream energy via MLPX for its simplicity and diversification. For a non-specialist, trying to pick winners in this space is a difficult task. Why not simply own the best 27 names and call it a day?

While the stock prices of MLPX's holdings tend to fluctuate with the swings in oil and gas prices, the fundamentals of this sector typically remain resilient through energy's ups and downs.

For the value investor wishing to earn quick rewards from a pop in oil prices, MLPX isn't the fund for you. But for dividend growth investors wishing to balance a nice 6% yield with steady appreciation and low- to mid-single-digit dividend growth, MLPX is a great choice.

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