Income is one of the primary reasons that some investors opt for the midstream over other corners of the energy patch that are more levered to oil and natural gas prices.
While those prices are indeed soaring this year and the energy sector is the best-performing group in the S&P 500, the allure of the 7.78% dividend yield on the ALPS Alerian MLP ETF (NYSEArca: AMLP) is perhaps too tempting for some income-starved investors to ignore.
After all, AMLP’s dividend yield is roughly six times what investors earn on the S&P 500. However, as seasoned dividend investors know, high dividend strategies do come with some risks, including the potential for companies with lofty payouts being financially burdened by those obligations and ultimately paring those dividends.
In bygone eras of active consolidation, too much capital spending, and oil bear markets, some midstream energy companies were dividend offenders. Fortunately for investors considering stakes in AMLP, the recently concluded third quarter indicates that this scenario is improving.
“Company commentary on earnings calls and in press releases reinforces expectations for future dividend growth with more clarity likely in the coming months. Consistent with the past, Enterprise Products Partners (EPD) plans to announce distribution growth guidance for 2022,” writes Alerian analyst Stacey Morris.
Enterprise Products Partners is the fourth-largest holding in AMLP at a weight of 9.79%. Energy Transfer (ET), which accounts for over 9% of AMLP’s roster, is another midstream operator with a potentially compelling payout outlook.
“While not specific to dividend increases, Energy Transfer (ET) noted that strong 2021 performance is creating the potential for dividend increases and/or buybacks beginning in 2022,” adds Morris.
Perhaps it was prompted by the oil bear market caused by the coronavirus pandemic, or maybe there were other motivating factors, but the reality today is that midstream energy firms are prioritizing balance sheet strength and the ability to sustain and grow shareholder rewards. In addition, the political environment isn’t conducive to large-scale new projects, and operators are likely enjoying their suddenly strong balance sheets, so cap-ex could remain subdued for some time.
“Dividend increases and buyback activity are clear signs of management teams’ confidence in their businesses. An improving macro energy landscape, moderating equity yields, and significant free cash flow generation create a more constructive backdrop for dividend growth. While midstream investors can anticipate more guidance on 2022 payouts in the months ahead, the data points and commentary thus far contribute to a positive outlook,” concludes Morris.
Other funds with exposure to income-generating energy assets include the VanEck Vectors Energy Income ETF (EINC) and the Global X MLP ETF (NYSEArca: MLPA).
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.