Energy is the best-performing sector in the S&P 500 this year, and that’s a trend permeating an assortment of industries, including the midstream.
Just look at the VanEck Vectors Energy Income ETF (EINC), which is higher by more than 43% year-to-date and residing near all-time highs. All that with a dividend yield of 4.41%, which is jaw-dropping in today’s low-yield environment.
Combine that exceptional performance and that eye-catching yield, and it might be reasonable to assume that EINC and some of its holdings are richly valued. However, some analysts argue that the energy sector still has some attractive deals, and that includes pipeline operators.
“For investors looking for a combination of high dividend yields and undervaluation, the pipeline sector has several to choose from. However, investors need to understand that the price movement on these stocks may be more muted in the near term,” says Morningstar analyst Dave Sekera.
Historically, midstream assets, including EINC components, are viewed as being less correlated to oil and natural gas prices because these companies are engaged in the process, storage, and transportation of those commodities — not their exploration and production. While long-ranging data bear out that master limited partnerships (MLPs) are indeed less correlated to spot oil prices than exploration and production companies, there’s no denying that EINC is delivering the goods for investors this year.
“Midstream firms and partnerships generally hedge commodity exposure to fairly minimal levels, and higher oil and gas prices don’t provide much of a direct benefit,” notes Sekera.
Good news for investors considering EINC: Plenty of the exchange traded fund’s 30 holdings are considered undervalued by Morningstar. That group includes Kinder Morgan (NYSE:KMI) and Enterprise Products (NYSE:EPD), which combine for almost 12% of the ETF’s roster.
Also making the Morningstar list of undervalued pipeline operators are Energy Transfer (NYSE:ET) and Plains All American Pipeline (NYSE:PAA) — a duo combining for about 6% of EINC’s weight. Cheniere Energy (NYSE:LNG) and Plains Gp Holdings Lp (PAGP), which combine for over 8% of EINC, are also viewed as undervalued by Morningstar.
“For pipeline companies, volumes are more important than prices, and with many U.S. producers pledging to hold volumes relatively flat and live within cash flows in the short term, pipelines aren’t necessarily seeing the same expected volume uplift in the near term that they would have in cycles past,” concludes Sekera. “The key earnings driver will be growth capital spending in order to build pipelines and infrastructure to match where new gas drilling will occur with those storage facilities utilized to hold and market oil and natural gas.”
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