USAI - USAI: Energy ETF With 6% Dividend Yield And Exposure To Midstream Companies

2023-06-02 06:39:27 ET

Summary

• Pacer American Energy Independence ETF offers exposure to midstream energy companies in the US and Canada, providing a less volatile and higher-yielding alternative to traditional energy ETFs.
• With a dividend yield of around 6.4%, USAI's focus on midstream companies ensures a stable income stream, making it an attractive option for investors amid economic uncertainty.
• Despite a higher expense ratio of 0.75%, the unique selection criteria and exposure to the midstream energy industry justify the cost.

Pacer American Energy Independence ETF (USAI) gives exposure to US and Canadian companies that generate most of their cash flow from midstream energy operations. With AUM of about $44M, USAI tracks the American Energy Independence Index. This ETF's holdings are unique and very different compared to most energy ETFs. The most enticing thing about this ETF is its impressive dividend yield of about 6.4%. Because of USAI's exposure to midstream companies, it is less volatile than most energy ETFs, while still remaining relatively correlated with oil. Because of USAI's impressive dividend yield and concentration on midstream companies, I believe it is a better option than most energy ETFs and am rating it a Buy with an outlook of 12-24 months.

Holdings

USAI has unique criteria for selecting and weighting its holdings. First, the US and Canadian equity markets are screened for companies that are mostly involved in midstream energy business operations. Second, any companies that meet criteria one are excluded if they pay incentive distribution rights or have a market cap of less than $500M. This ensures that only well-developed mid and large-cap stocks are included in USAI. Finally, the holdings are weighted so that 80% of the fund's holdings are in US and Canadian midstream companies and the remaining 20% is in U.S. midstream MLPs and general partners of MLPs. After all three criteria are screened for, as of June 1st, they are left with 33 companies. These companies are all weighted by market cap.

USAI's top 10 holdings make up about 58% of its AUM, with its top holding only being about 7%. USAI's holdings are very different compared to most energy ETFs. In fact, USAI only has a 9% overlap with the VDE , Vanguard's total energy sector ETF, meaning that this ETF offers exposure to companies that most energy index ETFs do not have.

As expected, USAI and XLE , the energy sector benchmark, perform relatively similarly; however, USAI recovered from the COVID-19 crash a little faster.

Advantages of Midstream Companies

Midstream companies are those that are involved with the processing, storage, transportation, and distribution of fuel, typically oil. Midstream companies are less volatile and come with less risk compared to upstream and downstream companies. Although midstream companies are correlated with the price of oil, they are far less correlated than upstream and downstream companies. Midstream companies usually have fixed fees that they charge for processing, storing, transporting, and distributing energy products. Although midstream companies' services experience more or less demand based on the price of oil, people will still need oil regardless of the price, and their services will always be needed, leading to a very stable income. Upstream and downstream companies' cash flows are more directly related to the current price of oil.

Volatility

Because midstream companies have a more stable stream of income, they tend to be less volatile than upstream and downstream companies. This is one of the reasons I believe USAI will be a better choice than a typical energy index in the coming 12-24 months. The only thing about the energy sector I am certain about right now is that there is a lot of uncertainty. Oil has always been a volatile commodity, but even more so now. One of my biggest concerns is interest rate uncertainty. A few days ago future markets were predicting a 65% chance of a June rate hike, and as of June 1st, it is down to 18% . Although it's looking like there won't be a June rate hike, Fed figures have hinted that they may pause in June, but then raise them later on this year. The more rates rise, the more the economy will slow. A slowing economy means less oil consumption, leading to lower oil prices, and as discussed before, less income for upstream and downstream companies. While midstream companies may be affected by large fluctuations in oil prices, they will be less volatile than energy indexes and are far less likely to have to cut their dividends because they will continue to bring in relatively stable income.

Dividends

Probably the most attractive feature of USAI is its dividend yield of almost 6.4% USAI has a much higher dividend yield compared to major energy index ETFs such as VDE and XLE.

USAI's current yield is about 2% higher than VDE and XLE. It also has a higher 4-year average yield than its peers. The chart below shows USAI's dividend yield since 2019. (The chart shows the current yield as 5.6% rather than Seeking Alpha's yield of 6.35 because of the different way they calculate the yield; Ycharts uses 30-day SEC yield while Seeking Alpha uses Yield ((TTM))).

Excluding the black swan event of COVID-19 in 2020, USAI has consistently remained at a yield of about 5.5% since 2019. This is because of how stable midstream companies' stream of income is. Oil has had many up and down swings since 2019, and again excluding 2020, the yield hasn't been impacted much, whereas if you look at VDE's yield (shown below), it is much less consistent, bouncing between 2% and 4%

Looking forward, there is no reason to believe that USAI's stable dividend history isn't going to continue. Its holdings will continue to bring in income, regardless of oil prices, and therefore pay high, consistent dividends.

Expense Ratio

One downside to USAI is its hefty expense ratio of 0.75%, well above the average expense ratio of 0.47%. This means that for every $100 invested in USAI, the fund managers receive 75 cents a year. While this may not sound like a lot, in today's hyper-competitive ETF industry, it is a very expensive ETF. In my opinion, the expense ratio is justified because of the complicated criteria the ETF uses to choose the companies in it, and because there aren't many ETFs that offer exposure to the midstream energy industry.

Conclusion

I rate USAI a Buy because it is less volatile and offers a higher yield than most energy ETFs. Because of how uncertain the US economy's future is, I think this is a great investment to wait out the storm. Regardless of what oil does, USAI companies will continue to bring in cash and be able to pay strong dividends.

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