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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Infrastructure: Another Midstream Exit Opportunity

We have highlighted that investors should be looking at listed infrastructure as a better allocation than standalone midstream/MLP allocations, including this post last year, and this one from January.  Infrastructure continues to produce better outcomes for investors than midstream, with lower volatility and higher returns.  Continue to ignore these messages at your own peril. 

  • Midstream stocks and MLPs have bounced 100%+ off the latest multi-year low in late March, and they are enjoying a rare respite from fund outflows, despite fundamental challenges.
    • Midstream’s fundamental challenges include counterparty bankruptcy risk, activity and volume declines, heavy competition, reliance on OPEC, correlation to oil prices and high financial leverage
  • Without the stress of daily extreme volatility and negative stock performance, now is an ideal time to re-evaluate midstream exposure and consider (or re-consider) listed infrastructure.
    • Midstream volatility is likely to continue, the upswing we are on today could end up leading to another painful downswing.
    • Infrastructure includes midstream, so choosing infrastructure doesn’t mean you are giving up on midstream entirely.
  • Global listed infrastructure is a reasonable alternative that many investors are choosing to fill the role originally intended for their MLP allocations.
    • Infrastructure has consistently outperformed midstream over the last 1, 3, 5 and 10 years and has reliably grown income over that time period, in contrast to midstream.
    • Infrastructure has done a better job of keeping pace with broader equities, but with far lower volatility than MLPs and the S&P 500.

Another Exit Opportunity

Midstream has grown increasingly cyclical in recent years, related to the shorter cycle nature of shale production that drives midstream volumes and capital investment.  As expectations for production growth change, the outlook for midstream cash flow can swing dramatically. 

The cyclical nature of midstream has manifested itself in massive waves of stock price performance for midstream, both up and down.  Recent history suggests those short-term positive swings have been very good points of exit from midstream. 

The sector’s structural issues are creating bigger and bigger swings, with more income volatility as well.  The sector is not what it advertised when long-time investors made original allocations. 

The best times to sell in recent years have been after large moves up for the stocks, including late 2016, early 2018, early 2019, early 2020.  Today is one of those opportunities after gains of more than 100% across the sector from the bottom. 

Infrastructure: Consistent Performance

Shown in the chart above for contrast, the FTSE Global Infrastructure Core 50/50 Index has produced superior returns to midstream, driven by the diversification of the index, high barriers to entry and cash flow visibility.

The return has not been driven by multiple expansion, which may surprise you.  In fact, multiples remain well below those in the private market (see our whitepaper on the subject).

Exciting things are happening across infrastructure, including several secular growth themes tied to data consumption and de-carbonization.  It is a sensible replacement for what you hoped for when you invested in midstream.

Infrastructure: Much Lower Volatility

In the chart below, we highlight the volatility of the FTSE Global Infrastructure Core 50/50 Index vs. the Alerian MLP Index and vs. the S&P 500.  In addition to midstream lagging in returns, it is doing so with much higher volatility.

Update on Dividend Growth

The flashy high yields that appear to be offered by midstream stocks and MLPs can be alluring, but the decline in income and stock prices over the years have more than offset the ultimate income received by investors.

MLP income reductions continued in 1Q 2020, with more than 25 distribution and dividend cuts across the midstream sector, from gathering & processing MLPs to Canadian midstream corporations. Consistent dividend growth from infrastructure has added up to a very large positive number, compared with a large negative number for MLPs. 

MLP distributions are expected to decline for a 6th straight year this year, compared with consistent dividend growth for infrastructure.  You pay more up front for that dividend consistency and visibility, but over time you end up at a higher number with much less consternation along the way.

In fact, the income an investor would have received from an MLP portfolio would have been down 40% from 2014 to 2020, while the same income an investor would have received from an infrastructure portfolio would have been up 55%!

Conclusion: Take a Step Back, See the Infrastructure Beyond the Pipes

Focusing on a niche and nailing the timing can have a happy ending. But in the midstream and MLP space, more often it is a violent stop and start of positive and negative swings tied to big swings in oil prices.  After this most recent decline and strong bounce off the bottom, we believe now is the time to evaluate midstream exposure and how you can avoid the potential of another big downturn.

Rather than wait for the next downdraft in midstream, take a fresh look today and make sure you are getting what you signed up for with midstream.  Food for thought as you enjoy this rally.

CBRE Clarion manages a global listed infrastructure strategy on behalf of institutional clients. We are sub-advisor for a mutual fund here in the U.S., a global UCITs fund and a fund in Australia.  We have been managing the infrastructure strategy for more than 8-years.