Is It Time To Buy The ALPS Alerian MLP ETF?

| About: ALPS Alerian (AMLP)

Summary

With over $7BN in assets, institutional investors still look at AMLP as a yield and energy play.

The 24 holdings of the ETF, like energy prices, have continued a downward path for the past year.

We analyze the holdings and the all important tax liability from "phantom income/losses" and provide our recommendation.

The ALPS Alerian MLP ETF (NYSEARCA:AMLP), is a relatively young ETF (inception date August 25, 2010) that tracks the performance of the Alerian MLP Infrastructure Index. The ETF holds U.S. large and mid-cap energy stocks classified as Limited Partnerships or LPs. Its investments are in companies that earn the majority of their cash flow from the transportation, storage, and processing of energy commodities. The holdings are weighted based on market capitalization.

The ETF along with energy investments, overall, have suffered for the last year. The dividends have continued to provide a high rate of interest, but investors have underperformed other sectors. We look at the ETF, compare it to the underlying index and determine if an investment now or buying for the dividend going forward is worth the risk. We also look into a tax liability that has surprised LP holders and some ETF shareholders over the past year.

The underline index, named the Alerian MLP Infrastructure Index is:

A composite of energy infrastructure Master Limited Partnerships {MLPS}. The index is a capped, float-adjusted, capitalization-weighted index, whose constituents earn the majority of their cash flow from the transportation, store and processing of energy commodities.

The quarterly dividend paying ETF is structured with 100% of its holding classified as common equity shares. The market cap of those shares is structured as: 53.14% mid cap, 30.53% large cap, 16.32% small cap and 0.01% other by Fidelity.com. Morningstar, as we previously stated in our other articles, uses a slightly different structure, starts with 72.60% medium cap, 17.27% small cap, 9.32% large cap and 0.81% micro cap. The ETF presently holds 24 holdings, one Institutional Money Market fund, plus a small amount of cash and equivalents as a debit balance. All sources agree that the style of the holdings and the ETF are classified as a "Mid" style, which places it as a Value investment. The geographic and currency weight structure of the holdings are fairly simplistic as well.

AMLP geographic and currency exposure

Country Weight Currency Weight
United States 97.88% United States dollar 97.88%
Netherlands 2.12% euro 2.12%
Click to enlarge

The exposure to the euro currency (via the Shell Midstream Partners LP (NYSE:SHLX)) has relatively little effect on this ETF and is not a concern going forward.

The sector is approximately 100% energy as noted, but one of our sources does partition the industry within the ETF to Oil & Gas Pipelines at 96.10% and Oil Refinery & Marketing at 3.90%. The Index, symbol [AMZ], with 22 components, according to the sponsor, is broken down as follows: Pipeline Transportation/Petroleum 44.10%, Gathering and Processing 29.50% and Pipeline Transportation/Natural Gas at 26.40%.

In order to properly ascertain the holdings, we analyzed each of the MLPs. We decided to review their current weightings within the ETF, ratings, (Moody's and S&P), performance, and dividends.

AMLP holdings

Name

Symbol

Ratings

(Moody's/

S&P)

Perf 12-month/

YTD

Yearly

Dividend

Weight
Energy Transfer Partners LP ETP Baa3/BBB-

-43.91/

-9.34%

13.55% 11.05%
Enterprise Products Partners LP EPD Baa3/BBB+

-25.87%/

-5.61%

6.45% 10.07%
Magellan Midstream Partners LP MMP Baa1/BBB+

-13.80%/

-3.35%

4.67% 9.35%
Buckeye Partners LP BPL Baa3/BBB-

-12.66%/

-1.37%

7.23% 7.99%
Plains All American Pipeline LP PAA Baa2/BBB

-57.78%/

-11.54%

13.61% 7.30%
MPLX LP MPLX Baaa3/BBB-

-61.26%/

-29.57%

7.05% 6.24%
Williams Partners LP WPZ Baa3/BBB-

-59.36%/

-29.00%

17.12% 4.64%
Sunoco Logistics Partners LP SXL WR/BBB

-42.78%/

-8.51%

8.07% 4.57%
ONEOK Partners LP OKS Baa2/BBB

-26.18%/

0.47%

10.46% 4.53%
EQT Midstream Partners LP EQM Ba1/BBB-

-7.59%/

-5.87%

3.93% 3.75%
Enbridge Energy Partners LP EEP Baa3/BBB

-51.30%/

-25.35%

13.42% 3.54%
Western Gas Partners LP WES Ba1/BBB-

-35.96%/

-15.08%

7.63% 3.01%
Spectra Energy Partners LP SEP Baa2/BBB

-9.57%/

-0.89%

5.46% 2.92%
Genesis Energy LP GEL Ba3/BB-

-33.80%/

-18.20%

8.53% 2.73%
Tesoro Logistics LP TLLP Ba2/BB

-19.38%/

-15.60%

7.26% 2.47%
NuStar Energy LP NS NR/BB+

-36.55%/

-4.59%

11.13% 2.38%
DCP Midstream Partners LP DPM NR/BB

-29.33%/

2.80%

12.09% 2.24%
TC Pipelines LP TCP Baa2/BBB-

-23.01%/

-4.22%

7.44% 2.15%
Shell Midstream Partners LP SHLX NR/NR

-7.88%/

-14.28%

2.47% 2.12%
Boardwalk Pipeline Partners LP BWP Baa3/BBB-

-9.61%/

9.75%

2.76% 1.69%
EnLink Midstream Partners LP ENLK Ba2/BBB-

-53.91%/

-35.22%

13.57% 1.45%
Phillips 66 Partners LP PSXP Baa3/BBB

-8.02%/

4.04%

2.89% 1.45%
Antero Midstream Partners LP AM NR/NR

-10.69%/

-6.58%

4.03% 1.20%
Cheniere Energy Partners LP CQP WR/BB

-8.92%/

7.57%

6.12% 1.17%
Morgan Stanley Institutional Liquidity Funds Prime Portfolio MPFXX Aaa/AAA

0.00%/

0.00%

0.41% 0.06%
Cash & Equivalents - - - - -0.07%
Click to enlarge

It is obvious the holdings in the ETF have suffered tremendously over the past year but it is interesting that a few have done well since the start of the year. Boardwalk Pipeline Partners LP is up 9.75% YTD, while it is -9.61% for the past 12 MTD and Cheniere Energy Partners LP, CQP, is up 7.57% YTD, while being down -8.92% 12 MTD. In terms of dividends, the holdings as per their overall structure continue to pay large dividends with the largest weighted holding, Energy Transfer Partners LP yielding 13.55% going forward, and others such Williams Partners yielding 17.12%.

The biggest concern as many investors and analysts have cited is not a dividend cut, but a default and the tax ramifications of a write off. We examined the ratings as noted above. The breakdown and a recent Moody's analysis is actually fairly positive and not as pessimistic as some stated. Here is the up to date credit structure of AMLP.

AMLP Credit Ratings

Moody's Ratings Weight S&P Ratings Weight
Aaa 0.06% AAA 0.06%
Baa3 46.67% BBB+ 19.42%
Baa2 16.90% BBB 24.31%
Baa1 9.35% BBB- 41.97%
Investment Grade 72.98% Investment Grade 85.76%
Ba3 2.73% BB+ 2.38%
Ba3 3.92% BB 5.88%
Ba1 6.76% BB- 2.73%
WR 5.74% - -
NR 7.94% NR 3.32%
Non Investment Grade+NR/WR 27.09% Non Investment Grade +NR 14.31%
Click to enlarge

As noted above, Moody's classifies almost 73% of the holdings as investment grade and S&P states almost 86% are in that classification. Though we use ratings only as a general guideline, particularly after the financial crises, there is some merit to their analysis. In a recent research piece dated February 18, Moody's Investors Service concluded a review of U.S. Baa-rated E&P companies and 2 MLPs. There were some downgrades due to the cost pressures combined with lower oil prices. The research does acknowledge that "the ability to generate cash flow has fallen substantially."

In terms of the holdings of the ETF, Western Gas Partners LP was downgraded to Ba1 from Baa3 with a negative outlook. The LP parent company, by the way, Anadarko (NYSE:APC), was also downgraded. The research piece cited exposure to production volumes as a risk along with Anadarko now having a below investment grade rating. The LP rating effectively cannot be higher than the parent company. Another holding, EQT Midstream Partners was confirmed at Ba1, with a stable outlook.

Overall, we tend to look at the ETF as a prudent way to achieve industry exposure and diversify MLP holdings while obtaining a high dividend. If prices stabilize at these levels or move slightly higher, as per futures prices, these MLPs will continue paying a high dividend and provide a positive return for the holding period.

Many investors and analysts of MLPs have been concerned with a tax burden added on to their (negative) return. The nature of this, for those not familiar with this tax, is similar to what happens when old credit card debts are written off by a bank. In this case, it is similar to a relative or child with you as the primary account holder. The cardholder has credit card debt. They cannot pay the debt and it is forgiven by the bank after a period of time.

At the end of the year, you, as the account owner, receive a tax bill for the debt forgiven. Accounting and tax rules state that it is income in spite of the fact you never received anything in return. In the MLPs' case, when they are forced to restructure their debts to prevent a bankruptcy filing, one can find oneself with a tax bill at the end of the year. This situation is primarily in the Upstream LPs and less in the midstream ones. In AMLP's case, we needed to dig in more and see what has changed over the past year. The fund sponsor recognizes this expense as follows:

The Fund's accrued deferred tax liability, if any, is reflected each day in the Fund's net asset value per share. The deferred income tax expense/(benefit) represents an estimate of the Fund's potential tax expense/(benefit) if it were to recognize the unrealized gains/(losses) in the portfolio. An estimate of deferred income tax expense/(benefit) is dependent upon the Fund's net investment income/(loss) and realized and unrealized gains/(losses) on investments and such expenses may vary greatly from year to year and from day to day depending on the nature of the Fund's investments, the performance of those investments and general market conditions. Therefore, any estimate of deferred income tax expense/(benefit) cannot be reliably predicted from year to year. The 4.58% deferred tax expense represents the performance impact of accrued deferred tax liabilities for the fiscal year ended November 30, 2014.

Unfortunately, as the fund has stated above, "any estimate of this tax liability cannot be reliably predicted from year to year." We didn't understand why 2015 fiscal year was not reported on the sponsor's website. We reviewed the updated (March 31, 2016), prospectus and were actually surprised. Both 2014 and 2015 had the same management fees, 0.85%, which we will address shortly. 2014 did in fact have a tax liability of 4.58% for total expenses of 5.43%.

2015 had no tax liability but a tax loss of 12.25% for a total expense (including net current and deferred tax expenses/benefits) of -11.40%. Total deferred tax liabilities are reported as a decrease from NAV but unfortunately, losses that may result in a tax bite are not clearly presented elsewhere other than the prospectus. While digging further, the prospectus does state that the net investment loss (including deferred tax expenses/benefits) is -1.57% versus -.55% for each of the past two years, 2014 and 2013).

At the end of our analysis we were only slightly confused and can conclude that while the tax loss of -1.57% can result in a liability to the shareholders, it is not as costly as the original number of -11.40%. We would consult with a MLP tax accountant to ascertain the actual "tax bite," for each shareholder, but our conclusion is that it is not as large as the initial analysis.

We also expect this liability to not increase going forward, but obviously, this is based upon a market that will stabilize. It is also based upon the fact that the midstream market has had less restructuring than their upstream MLPs and the overall credit quality of AMLP is significantly investment grade, at least at this time.

AMLP's Performance, Fees and Recommendation

Category

AMLP

[ETF]

AMZ

[Index]

Net Expense Ratio 0.85% NA
Turnover Ratio 21.00% 21.00%
YTD Price Return

-13.69%

-11.72%

1-Year Price Return

-38.17%

-40.59%

Distribution Yield/SEC Yield 10.89%/8.08% NA

Beta, (3-yr) versus Morningstar MLP

Composite Tr USD/Fund Holdings

0.80/1.00

NA
P/E Ratio FY1/current 18.28 /18.05 NA
Price/Book Ratio FY1/current 1.51/1.33 NA
Click to enlarge

In terms of the net expense ratio for AMLP, it is slightly above the asset class median on 0.51%, while the turnover ratio of 21.00% is the asset class median. It should be noted that the prospectus states that the turnover percentage of the average value of the portfolio is actually 47% for 2015. Obviously, the return numbers are terrible and the overall growth in earnings (only 1.32%) is abysmal versus the asset class median of 10.67%, but institutions have been placing substantial assets in the ETF. They presently hold 42.69% of the ETF.

Over 84M was purchased in the ETF in the current quarter, with a net change of ownership of 21.66% from the previous quarter, with Morgan Stanley holding 4.53% as of 12/31/2015. While overall mutual funds have only a small presence at 0.23%, (perhaps due to tax headaches), they did increase their holdings by 12.81% in the current quarter.

Our overall recommendation is to take advantage of the low prices of the ETF, high quarterly yields, relatively stable MLPs, and dollar cost average into AMLP. Granted, it is not without risks going forward. Oil prices could continue to decline, credit conditions could spread to midstream components and shareholders could get hit with larger tax liabilities on gains (losses). Overall, at this time, we would follow the "smart money" carefully, and take advantage of the opportunity in this ETF.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Analysis and research/data was from: fidelity.com, morningstar.com, yahoofinance.com, tdwaterhouse.ca, standardandpoors.com, moodys.com, xtf.com, alpsfunds.com, seekingalpha.com and our own analysis.