Midstream equities outperformed the broader markets in October as third-quarter earnings season kicked off with better-than-expected results. Increasing midstream free cash flows are expected to bolster improve balance sheets in the years ahead as capital spending requirements have ebbed.
MLP market overview
Midstream MLPs, as measured by the Alerian MLP Index (AMZ), ended October up 2.9% on a price basis and up 4.3% once distributions are considered. The AMZ outperformed the S&P 500 Index’s 2.7% total return loss for the month. The best performing midstream subsector for October was the Gathering and Processing group, while the Diversified subsector underperformed, on average.
For the year through October, the AMZ is down 48.7% on a price basis, resulting in a 43.5% total return loss. This compares to the S&P 500 Index’s 1.5% and 3.1% price and total returns, respectively. The Propane group has produced the best average total return year-to-date, while the Diversified subsector has lagged.
MLP yield spreads, as measured by the AMZ yield relative to the 10-year US Treasury bond, narrowed by 73 basis points (bps) over the month, exiting the period at 1,337 bps. This compares to the trailing five-year average spread of 678 bps and the average spread since 2000 of approximately 415 bps. The AMZ indicated distribution yield at month-end was 14.2%.
Midstream MLPs and affiliates raised no new marketed equity (common or preferred, excluding at-the-market programs) or debt during the month. No new asset acquisitions were announced in October.
West Texas Intermediate (WTI) crude oil exited the month at $35.79 per barrel, down 11.0% over the period and 33.9% lower year-over-year. Natural gas prices ended October at $3.35 per million British thermal units (MMbtu), up 32.7% over the month and 27.4% higher than October 2019. Natural gas liquids (NGL) pricing at Mont Belvieu exited the month at $19.90 per barrel, 4.6% higher than the end of September and 9.6% lower than the year-ago period.
Energy Transfer making changes. Energy Transfer (ET) announced that Kelcy Warren will turn over the Chief Executive Officer position to long-time ET executives Mackie McCrea and Tom Long, effective Jan. 1, 2021. Warren will remain as Executive Chairman and Chairman of the Board of Directors. As Co-CEOs, McCrea and Long will work together in the manner of an “Office of the CEO” and will jointly direct the business of the Partnership. Warren will continue to be actively involved in the strategic direction of the Partnership. Later in the month ET elected to reduce its distribution by 50% and, likely, increase its focus on debt reduction. Standard and Poor’s immediately affirmed Energy Transfer’s investment grade rating (BBB-) and Moody’s affirmed its investment grade rating (Baa3) the following day.
Third-quarter earnings season commences. Third-quarter reporting season began in October. Through month-end, 47 midstream entities had announced distributions for the quarter, including four distribution increases, two reductions, and 41 distributions that were unchanged from the previous quarter. Through the end of October, 11 sector participants had reported third-quarter financial results. Operating performance has been, on average, better than expectations with EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization, coming in 5.5% higher than consensus estimates and 9.9% higher than the preceding quarter.
TRP Proposes to Buy TCP. TC Energy (TRP CN) made a non-binding offer to acquire all outstanding common units of TC Pipelines (TCP) that it does not already own, with an exchange ratio of 0.65 common units of TRP for each unit of TCP, representing an implied value of $27.31/unit based on the Oct. 2 closing price of TRP, or a 7.5% premium to the 20-day weighted average price of TCP common units. A Conflicts Committee composed of independent directors of the TCP Board will be formed to consider the offer pursuant to its processes.
Chart of the month: rising free cash flow bolsters midstream balance sheets
As midstream cash flows have remained resilient, and as the industry continues to rationalize capital spending, estimates for sector free cash flow1 have significantly increased. Further, as market participants are no longer rewarding distribution growth, midstream energy sector participants are largely expected to hold distributions steady and let excess cash flow accrue to the balance sheet.
The chart below presents estimates from Wells Fargo for total free cash flow and distributions/dividends for the publicly traded US midstream companies through 2025. We believe the difference between each year’s free cash flow and the cash payouts to equity investors may be used to reduce borrowings and, to a lesser extent, buyback undervalued equity units.
Source: Wells Fargo as of 10/31/2020.Past performance does not guarantee future results. “E” represents estimates. No guarantee that estimates will come to pass. Free cash flow is defined as distributable cash flow less growth capital expenditures and acquisitions, where distributable cash flow represents cash flow generated by the company’s operations reduced by expenditures to maintain the assets.
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Source: All data sourced from Bloomberg as of 10/31/2020 unless otherwise stated.
- Defined as distributable cash flow less growth capital expenditures and acquisitions, where distributable cash flow represents cash flow generated by the company’s operations reduced by expenditures to maintain the assets.
The opinions referenced above are those of the author as of Nov. 2, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
Midstream operators and companies are engaged in the transportation, storage, processing, refining, marketing, exploration, and production of natural gas, natural gas liquids, crude oil, refined products or other hydrocarbons.
The mention of specific companies, industries, sectors, or issuers does not constitute a recommendation by Invesco Distributors, Inc. A list of the top 10 holdings of each fund can be found by visiting invesco.com.
As of 9/30/2020, Invesco SteelPath MLP Alpha Fund, Invesco SteelPath MLP Income Fund, Invesco SteelPath MLP Select 40 Fund and Invesco SteelPath MLP Alpha Plus Fund held 13.91%, 12.47%, 4.98% and 13.79%, respectively in Energy Transfer LP.
As of 9/30/2020 Invesco SteelPath MLP Alpha Fund, Invesco SteelPath MLP Income Fund, Invesco SteelPath MLP Select 40 Fund and Invesco SteelPath MLP Alpha Plus Fund held 10.15%, 0.00%, 4.59% and 9.97%, respectively in TC Pipelines LP.
The S&P 500 Index is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
The Alerian MLP Index is a float-adjusted, capitalization-weighted index measuring master limited partnerships, whose constituents represent approximately 85% of total float-adjusted market capitalization. Indices are unmanaged and cannot be purchased directly by investors.
Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. An investment cannot be made into an index. Past performance does not guarantee future results
A yield spread is the difference between yields on differing debt instruments of varying maturities, credit ratings, issuer, or risk level, calculated by deducting the yield of one instrument from the other.
Most MLPs operate in the energy sector and are subject to the risks generally applicable to companies in that sector, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk. MLPs are also subject the risk that regulatory or legislative changes could eliminate the tax benefits enjoyed by MLPs which could have a negative impact on the after-tax income available for distribution by the MLPs and/or the value of the portfolio’s investments. Although the characteristics of MLPs closely resemble a traditional limited partnership, a major difference is that MLPs may trade on a public exchange or in the over-the-counter market. Although this provides a certain amount of liquidity, MLP interests may be less liquid and subject to more abrupt or erratic price movements than conventional publicly traded securities. The risks of investing in an MLP are similar to those of investing in a partnership and include more flexible governance structures, which could result in less protection for investors than investments in a corporation. MLPs are generally considered interest-rate sensitive investments. During periods of interest rate volatility, these investments may not provide attractive returns.
Energy infrastructure MLPs are subject to a variety of industry specific risk factors that may adversely affect their business or operations, including those due to commodity production, volumes, commodity prices, weather conditions, terrorist attacks, etc. They are also subject to significant federal, state and local government regulation.
The opinions expressed are those of Invesco SteelPath, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Before investing, investors should carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the fund(s), investors should ask their advisors for a prospectus/summary prospectus or visit invesco.com.