Data as of March 31, 2018 unless otherwise noted
Performance (total returns)
|Alerian MLP Index (AMZX)||-6.94%||-11.12%|
|Alerian Midstream Energy Select Index (AMEIX)||-3.40%||-13.21%|
|ICE BofAML U.S. High Yield Energy Index (HY Energy)||-0.86%||-0.96%|
|S&P 500 Energy Index (S&P Energy)||1.66%||-5.88%|
Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.
FERC adds to midstream woes: The rally in MLPs and energy infrastructure in January now feels like a distant memory. March started out positive, with both midstream indices rising over 1% for the first half of the month. However, the Federal Energy Regulatory Commission (FERC) ruling on March 15, which will likely eliminate an income tax allowance for certain MLP-owned interstate pipelines, sent both MLP and non-MLP infrastructure companies lower. While many market participants expect the impact from FERC to be limited to only a handful of MLPs, this additional piece of negative news reinforced the negative sentiment already surrounding the sector. Against what would typically be viewed as a favorable fundamental backdrop, steady commodity prices and increasing production, MLPs and other energy infrastructure companies continue to move lower. HY Energy also fell for the month, but its decline was generally in line with broader weakness in the high yield bond market. S&P Energy, given its large exposure to upstream companies, rose alongside higher oil prices, which finished the month up 5.4%.
Midstream valuations look attractive: As midstream earnings prospects remain generally favorable and stock prices continue to move lower, valuation metrics for midstream companies look increasingly attractive. According to Wells Fargo, its midstream MLP universe is currently trading at a 24% discount based on yield and an 18% discount based on enterprise value to EBITDA (EV to EBITDA) compared to 10-year averages.1 Similar discounts are also observed for non-MLP midstream companies. The EV to EBITDA ratio, which serves as a proxy for price to earnings, is at its lowest level since Q3 2009 and in the bottom 10% of all results since 2005.1 If this ratio recovered so that the EV to EBITDA ratio traded at a level representing only one-third of its max value since 2005, that would imply a 25% price increase for investors. While negative investor sentiment continues to weigh on the midstream sector, metrics based on yield, valuation and earnings appear more and more compelling.
While business fundamentals for the energy sector remain generally supportive, investor sentiment, especially for MLP and midstream equities, remains particularly negative. This has resulted in what we believe are historically cheap valuations for energy infrastructure.