The Strong Fundamentals Underpinning Pipelines
Recently a long-time investor Jeff Waters suggested that it might be interesting to dig a little deeper into the valuation metrics that make midstream energy infrastructure such an attractive sector. It resulted in a podcast interview, which you can access here.
The roughly 2/3rds drop in growth capex since 2018 underpins an improving cash flow story. The components of the American Energy Independence Index (AEITR) have a market-cap weighted Free Cash Flow (FCF) yield of 10%. This is almost 2X the dividend. Longtime MLP investors will recall the common practice whereby MLPs paid out 90% or more of their Distributable Cash Flow. This left very little room for error.
Since 2016 the payout on the MLP-dedicated Alerian MLP ETF (AMLP) is down by half. Corporations have done better because they generally have higher coverage. Today’s pipeline CFO is building in plenty of cushion to protect payouts even in a steep downturn, which is why dividend hikes and buybacks are becoming more common.
JPMorgan just published a slide deck titled, “North America Long + World Short Hydrocarbons = Logistics Tailwinds.” An already positive outlook improved with Russia’s invasion of Ukraine in February. There is no plausible scenario in which Europe restores its reliance on Russian natural gas. The US has ample supplies available at low extraction costs. LNG exports will grow as fast as new facilities can be built.
The table below highlights some of the metrics which illustrate why we believe pipelines still have plenty of upside. For example, the sector’s 9X EV/EBITDA is more than 1.0X below the average since 2019. Returning to the mean would generate at least 15% capital appreciation.
Investment grade Debt:EBITDA leverage of 3.5X continues to trend lower. Five years ago Kinder Morgan argued unsuccessfully to rating agencies that >5X was justified because of their diverse set of businesses. The industry has embraced a more conservative operating model.
It’s also worth remembering the driving force behind increased global energy demand – rising living standards. The chart below is several years old, but still neatly illustrates the close relationship between living standards and energy use. America’s per capita consumption may not be what the world should emulate, but there is no doubt that billions of people want to move up and to the right. This will endure as the dominating force in energy markets for decades to come, overwhelming rich countries’ desire for reduced greenhouse gas emissions. The last couple of years have exposed the inadequacy of extreme green policies followed in the EU and certain US states. Once again Californians are enduring a heatwave with insufficient power capacity.
Carrie Bentley, a former policy official with the California Independent System Operator, said California had allowed too much fossil fuel capacity to be shut down without adequate renewable sources and large-scale back-up batteries. She admitted, “We retired too many gas plants too early.”
A reassessment of extreme climate policies should work to the benefit of natural gas by increasing its substitution for coal burning power plants.
Elizabeth The Great
So said ex-PM Boris Johnson in his moving eulogy to the British House of Commons on Friday. King Charles III referred to “a promise with destiny kept.” I have felt a surprising sadness at Queen Elizabeth II’s passing, similar perhaps to losing a distant but benevolent aunt. Rarely for me, I have a desire to be in England at this time, an emotion I only previously felt when our team played in the European Cup Final last year at Wembley, London. She was a constant during times of change; queen for my entire lifetime and an apolitical figurehead often when one was most needed.
My grandparents tolerated no criticism of the royal family during my childhood. They remembered then-Princess Elizabeth and her parents enduring the German blitz of 1940 alongside other Londoners. Simon Schama, the erudite writer who chronicles major current events from the perspective of history’s great arc, called Elizabeth, “quintessential Britain; not all of it, of course, but more than the head of state — the heart of the matter, the personification of a common, idealised identity.”
Some Americans will question that hereditary leadership should provoke such sentimentality. I’ve never heard any regrets that George III was dumped in 1776.
But to be a British subject is to embrace the Crown. I live joyfully in America but part of me will always be there.
We have three funds that seek to profit from this environment:
Please see important Legal Disclosures.
The information provided is for informational purposes only and investors should determine for themselves whether a particular service, security or product is suitable for their investment needs. The information contained herein is not complete, may not be current, is subject to change, and is subject to, and qualified in its entirety by, the more complete disclosures, risk factors and other terms that are contained in the disclosure, prospectus, and offering. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy, completeness or timeliness of this information. Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments. Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.
References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and do not reflect the deduction of the advisor’s fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios managed by SL Advisors as they have different underlying investments and may use different strategies or have different objectives than portfolios managed by SL Advisors (e.g. The Alerian index is a group MLP securities in the oil and gas industries. Portfolios may not include the same investments that are included in the Alerian Index. The S & P Index does not directly relate to investment strategies managed by SL Advisers.)
This site may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involves a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of SL Advisors LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made. r
Certain hyperlinks or referenced websites on the Site, if any, are for your convenience and forward you to third parties’ websites, which generally are recognized by their top level domain name. Any descriptions of, references to, or links to other products, publications or services does not constitute an endorsement, authorization, sponsorship by or affiliation with SL Advisors LLC with respect to any linked site or its sponsor, unless expressly stated by SL Advisors LLC. Any such information, products or sites have not necessarily been reviewed by SL Advisors LLC and are provided or maintained by third parties over whom SL Advisors LLC exercise no control. SL Advisors LLC expressly disclaim any responsibility for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on these third-party sites.
All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.
Past performance of the American Energy Independence Index is not indicative of future returns.
In terms of returns, I would like to note that there are still MLPs with high sustainable well covered yields. They include, but are not limited to, EPD, CEQP, MPLX, USAC, ET and many others.
I should have added WES to my above list of MLPs with high sustainable well covered yields.