2023-03-06 23:30:59 ET
Summary
- MLPs' strong free cash flow generation leads to nice dividends, buybacks and debt reductions.
- This translates into a very low risk of dividend cuts and hence a positive backdrop for a continued MLP bull market.
- AMZA is a leveraged bet on this trend.
- Its actively managed portfolio yields 8.6%.
In a previous article we already made the case for MLPs in general and the ALPS Alerian MLP ETF ( AMLP ) in particular. Today we take a look at the InfraCap MLP ETF ( AMZA ). While both ETFs invest in more or less the same securities, AMZA is still a different animal. AMZA uses, for starters, leverage and it uses options strategies to provide a source of additional income. The leverage results in higher returns in an bull market (and vice versa in a bear market), while the option income translates in a higher dividend yield. AMZA has a dividend yield of 8.62% versus a yield of 7.76% for AMLP. The outlook remains bright for energy in general and MLPs in particular and this warrants a buy-rating on (the higher risk) AMZA ETF.
Leverage and higher beta
The massive expansion of capacity, driven by massive investment in new pipelines in the years before, caused the price of transporting oil to stagnate between 2015 and 2020. Many MLPs had to cut their dividends and this disappointed many income-oriented investors.
Figure 1: Total return chart (Yahoo! Finance, Author)
Also the onset of the pandemic, crashing energy markets, and significant uncertainty led to another round of dividend cuts in 2020 and again a very bad performance for MLPs.
Of course this period of over-investment was followed by a period of low capex. US Midstream capex halved in 2020 and is expected to remain on those lower levels for the foreseeable future.
This lower capex has improved returns for investors. Since the start of the Covid-crisis MLPs have outperformed the S&P 500.
Figure 2: Total return chart (Yahoo! Finance, Author)
Since the beginning 2022 MLPs kept performing well, while equities in general fell due to the Fed rate rises.
Figure 3: Total return chart (Yahoo! Finance, Author)
There is one constant in the above three charts: AMZA has a higher beta compared to the other MLP ETFs. This higher beta can be explained by the leverage that is used by AMZA.
Another remarkable feature in Figure 3 is the sharp drop in June 2022, when oil prices tumbled lower, while Midstream MLPs are considered to have a low commodity linkage. They get paid by the volumes they are transporting through their pipelines no matter what the price of oil is at that moment or how volatile the oil price is. But, is this really the case? Pipeline volumes might in the short term be unaffected by swings in energy prices, but in the longer term the transported volumes depend on how much oil is drilled. And the amount of oil that is drilled depends of course on the price of oil.
This higher than assumed link with energy commodity prices is not necessarily a bad thing in our eyes because we are positive on the energy sector.
Capex discipline is not only present in the midstream but in the whole energy sector. The ongoing underinvestment in exploration and production leads to a lower supply for years to come and this will support energy prices.
Despite a fairly low oil price, the energy sector remains one of the equity sectors in a long term uptrend.
Figure 4: Trends (Yahoo! Finance, Author)
Valuation
MLP performance is supported by the strong free cash flow generation and the expected juicy dividends and buybacks. But what about the valuation?
When we compare MLPs to other income oriented sectors, like bonds, REITs and equities, they come out on top.
Figure 5: Valuations (Global X)
Only the yield of high yield bonds is higher. But we would like to point out that the MLPs have higher credit quality compared to high yield bonds. 74.9% of the Alerian MLP Infrastructure Index, which serves as the benchmark for AMZA, has an investment-grade rating.
Not only is the dividend yield of MLPs higher than those of REITs and Utilities, also on a ratio like EV/EBITDA MLPs are much cheaper. And in comparison to its own history MLPs can also be called cheap.
Figure 6: Valuations (Global X)
AMZA
AMZA “provides exposure to midstream master limited partnerships (MLPs) with an emphasis on high current income”. It utilizes modest leverage (typically 20-30%) and options strategies are used in an effort to provide a source of income. Also on the level of security selection, the portfolio is actively managed. Securities are selected based on security-level fundamental analysis and technical factors instead of market capitalization.
To be included in the Alerian MLP Infrastructure Index , which serves as the benchmark for AMZA, midstream MLPs must have a market capitalization of at least $75 million and a minimum median trading volume of at least $5 million for the six months prior to the index’s data analysis date. Additionally, constituents must have declared a distribution for the trailing two quarters.
Below you can find the top 10 holdings to get an idea what’s inside the ETF.
Figure 7: Top 10 holdings (InfraCap)
As we said before, AMZA uses options to provide an extra source of income.
Currently AMZA has written put and call options on Enterprise Products Partners LP ( EPD ), Kinder Morgan ( KMI ) and Targa Resources ( TRGP ).
Call options are written on Energy Transfer LP ( ET ), Cheniere Energy ( LNG ), Magellan Midstream Partners LP ( MMP ), MPLX LP ( MPLX ), New Fortress Energy ( NFE ), Plains All American Pipeline LP ( PAA ), Western Midstream Partners LP ( WES ) and The Williams Companies ( WMB ).
And AMZA has written put options on ONEOK ( OKE ).
The option premiums help AMZA in achieving its 8.6% dividend yield.
The active management and the use of options and leverage result also in a hefty 1.64% total expense ratio.
MLPs are trending up nicely and this translates in green long term trends. AMZAs higher beta results also here in a higher long term trend score.
Figure 8: Trends (Yahoo! Finance, Author)
When the LT trend is clearly up, we get a green light/colour. Vice versa, when the LT trend is clearly down, we see a red light/colour. In between the colour is orange.
Figure 9: Total Return Chart (Yahoo! Finance, Author)
The ribbon in the price-part of the chart shows the LT trend-colour, while the lower part of the chart shows the ST trend. We left out the orange colouring to avoid overloading the chart.
Conclusion
Low capex in the midstream energy sector are again leading to higher transportation costs. This results in strong free cash flow generation and higher dividends and buybacks for midstream MLPs in the coming years.
In the past MLPs performed badly when they (had to) cut dividends. Currently, balance sheets are in good shape and the risk of dividend cuts is low. This translates in a positive backdrop for a continued MLP bull market. AMZA is a leveraged bet on this trend. Its actively managed portfolio currently yields 8.6%. Buy!
For further details see:
AMZA: 8.6% Yield For This Actively Managed And Slightly Leveraged MLP ETF