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Midstream Compares Favourably to Broader Energy and the European Majors | MMLP

North American Energy Infrastructure Offers Defensiveness and Higher Income Compared to the Majors or North American Energy Infrastructure Screens Favorably for Income, Defensiveness Compared to the Majors

The Alerian Midstream Energy Dividend UCITS ETF (MMLP), our midstream energy ETF, tracks the Alerian Midstream Energy Dividend Index (AEDW), which is a dividend-weighted index of US and Canadian energy infrastructure companies. While AEDW includes both corporations and Master Limited Partnerships (MLPs), which enjoy tax advantages in the US, all constituents in the midstream energy ETF are primarily focused on midstream activities, including transporting, processing, and storing hydrocarbons. In contrast to other energy subsectors, these activities are typically performed for fees, resulting in more stable cash flows. With this as context, how does AEDW compare to other energy indexes and the European majors from an investment standpoint?

Broad energy indexes tend to be significantly weighted to the integrated majors given their larger market caps. The Stoxx Europe 600 Oil & Gas Index (SXEP) had a combined 55% weighting to Total, Shell, and BP as of August 31. Similarly, the Energy Select Sector Index (IXE), which includes the energy companies in the S&P 500, has an approximately 45% weighting to Exxon and Chevron (Source Bloomberg). Notably, MLPs are excluded from broad US equity indexes and energy indexes like the IXE, providing added diversification relative to common energy allocations. Given the significant weighting to the majors in energy indexes and the greater likelihood of generalist investors owning these companies for energy exposure, it is important to understand how midstream compares to the majors. 

Both midstream and the integrated majors can be thought of as defensive energy investments but for different reasons. Midstream corporations and MLPs are defensive by nature of their feebased business model, which limits the impact of commodity price fluctuations on cash flows. This is evidenced by the stability in 2020 and 2021 EBITDA estimates for AEDW since the start of this year as shown in the table on the next page. Modest EBITDA revisions for midstream in the wake of the collapse in oil prices contrasts starkly with the significant downward revisions for other energy indexes and the European majors. Typically, the majors tend to be defensive as a function of their size, business diversification, balance sheet strength, and up until recently, their dividend track record. Shell, BP, and Eni cut their dividends this year by 67%, 50%, and 72%[1] , respectively. For investors looking to replace lost income from those stocks, an allocation to midstream could be an appealing opportunity given its attractive income profile and defensive performance. Looking at total-return performance year-to-date through early October, midstream has outperformed the broader energy indexes and the European majors. The outperformance of midstream is even more pronounced when comparing with those names with dividend cuts.

Midstream Compares Favourably to Broader Energy and the European Majors

Change in EBITDA Estimates from 31 January (pre-COVID) to 9 October:

Past performance is no guarantee of future performance All data as of 9/10/20. Source: Bloomberg

Given the relative defensiveness of the majors and midstream, both would be expected to provide upside in an oil price recovery while offering downside protection if the macro energy environment remains challenging. However, there is a noticeable variance in the correlations with Brent oil prices shown above. Despite its stable cash flow profile and more resilient equity performance this year, midstream has demonstrated a relatively high correlation with Brent. For investors anticipating an oil price recovery, midstream may represent an interesting opportunity to gain energy exposure while enjoying attractive income as the recovery continues. It bears noting that the exposure in the SXEP to utilities and renewable-focused companies like Vestas and Siemens Gamesa may provide less leverage to an oil price recovery. 

While the majors and midstream have defensiveness in common, there are some key differences in investment considerations to highlight, particularly the more attractive income and greater cash flow stability of midstream. Thus far in 2020, midstream has proven to be more defensive than its energy peers while offering greater income.

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To learn more about our midstream energy ETF, please visit our fund page.