MLPA: MLP ETF, Strong Energy Play, 10.8% Yield

Summary

• MLPA is an index ETF investing in energy MLPs.
• Energy companies, including MLPs, are quite risky and volatile, but possible capital gains would be outstanding if energy prices recover.
• MLPs also offer strong distribution yields, with MLPA yielding 10.8%.
• Risks are high but so are returns, and I'm quite bullish about the industry.
• This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Get started today »

The Global X MLP ETF (NYSEARCA:MLPA) is an index ETF investing in energy MLPs. MLPA offers investors a strong 10.8% distribution yield and the potential for substantial capital gains as economic conditions stabilize, but risks are high. The fund's holdings are strongly dependent on energy prices and economic conditions, expect sizable losses during downturns or commodity price crunches. I'm bullish about the economy, so I consider the fund a buy. On the other hand, due to its risky holdings, the fund is only appropriate for more bullish investors. Investors looking for safer funds and more dependable distributions should look elsewhere.

The Global X MLP & Energy Infrastructure ETF (MLPX) is similar to MLPA, but focusing on higher-quality midstream energy corporations. MLPX is more appropriate for more risk-averse investors, although its distribution yield of 7.5% and its potential capital gains are both lower compared to MLPA.

Fund Basics

• Sponsor: Global X
• Underlying Index: Solactive MLP Infrastructure Index
• Expense Ratio: 0.46%
• Distribution Yield: 10.80%
• Total Returns CAGR (Inception): -5.65%

Fund Overview - Risky High-Yield Energy Play

MLPA is an index ETF investing in MLPs. The fund tracks the Solactive MLP Infrastructure Index, a broad-based index of the same.

MLPs are a type of corporate structure with some benefits, drawbacks, and differences with more common corporations or C-corps. For the purposes of this article, the important thing is that MLPs are energy infrastructure companies focusing on the transportation, distribution, and storage of energy products. There are a couple of exceptions, none of which are included in MLPA or its parent index. Companies are also able to engage in these activities without being structured as MLPs, these are also not included in MLPA.

MLPs sometimes have complicated tax reporting standards, but that is not the case for MLPA. Investors don't have to file special forms, nor are there other important tax considerations, at least presently. Distributions were exclusively return of capital for 2020, so no taxes were liable for these.

(Source: MLPA Corporate Website)

MLPA's parent index invests in all MLPs meeting a basic set of size, liquidity, trading, and business focus criteria. The company invests in at least 20 MLPs. If there are not 20 companies meeting the index inclusion criteria, these are loosened until there are. Weights take into consideration distribution yield and expected distribution growth, but not market capitalization.

From what I've read, the index seems a bit kludgy and excessively complicated, almost certainly due to the small number of MLPs available. I think of these issues as something of a negative, but they are generally unavoidable if you want to invest in the industry.

Due to the above, MLPA is quite concentrated, with only 20 holdings, and with the top ten of these comprising 65% of the value of the fund. The fund's largest holdings are as follows:

(Source: MLPA Corporate Website)

Concentration serves to increase portfolio risk and volatility, and means that returns and distributions are dependent on the performance of just a couple of names. Expect significant losses and distributions cut if Energy Transfer (ET), the fund's largest holding, underperforms, for example. This isn't a purely theoretical concern, considering the fact that ET itself is a high-risk MLP, recently cut its distribution, and significantly underperformed during early 2020:

Data by YCharts

MLPA's holdings themselves are also quite different from other equities in most relevant characteristics. MSCI, one of the largest index providers in the world, measured MLPA's holdings in several important characteristics or investment factors. Results are as follows:

(Source: ETF.com)

The table above tells us basically all we need to know about MLPA and its holdings, so I thought to structure the rest of the article around these. Let's have a look.

Small, Risky, and of Low Quality

MLPA's holdings are quite small, and score badly on measures of balance sheet strength and stock price volatility. These three characteristics are related.

MLPA focuses on a very niche industry, in which companies are generally quite small (larger companies are mostly structured as C-corps to ensure inclusion in larger indexes and institutional investments). Smaller companies generally have weaker balance sheets and undiversified revenue streams, both of which massively increase revenue, earnings, and stock price volatility.

All of this is worsened by the fact that MLPA focuses on companies within the energy industry, which is itself quite volatile. Revenues and earnings are strongly dependent on energy prices, so are constantly fluctuating. Share prices are even more volatile, for the same reasons, and because these are also dependent on fickle investor sentiment.

MLPs and MLPA are very risky investments, which brings me to my next point.

Negative Momentum

The ongoing coronavirus pandemic has led to reduced demand for oil and reduced energy prices. These went down by up to 60% during the peak of the crisis, but have since recovered quite heavily, although remain down by about 15%:

Data by YCharts

Declining oil prices have led to plummeting energy industry valuations, with MLPs down by about 20%. Distributions meant that losses were smaller, but only insignificantly so, with MLP total returns still significantly lower than those of the broader energy industry and equities market.

Data by YCharts

MLPA's dreadful performance these past months has been disastrous news for the fund's shareholders, but does present something of an opportunity for future investors.

Strong 10.8% Distribution Yield

Lower share prices mean higher yields, and that is definitely the case for MLPA. The fund's distribution yield currently stands at 10.8%, significantly higher than that of other asset classes and the broader energy industry. It is also quite a bit higher than average, with MLPA usually trading with yields between 8-9%.

Data by YCharts

Higher distributions should directly lead to higher shareholder returns, a benefit for the fund and its shareholders. Yields are rarely this high, so investors should consider investing while this is the case, to lock in high yields.

On the other hand, investors should also be aware that MLPA's distributions are not safe. This is mostly due to the nature of the fund's holdings. As these depend on energy prices for their revenues, earnings, and cash-flows, distributions get cut during commodity price crunches and downturns.

As proof of the above, we can look at the fact that MLPA has seen negative distribution growth since inception, due to tough industry conditions these past few years.

(Source: Seeking Alpha)

MLPA also recently cut their distribution by about 8%, due to MLP distribution cuts during the pandemic. Further cuts are possible, although it seems that most of the impact from the pandemic has already been felt.

Cheap Price and Valuation - Possible Gains

MLPA currently trades at historical lows, and about 50% lower than its 2016-2019 average.

Data by YCharts

MLPA's low share price is the result of the ongoing coronavirus pandemic and attendant economic downturn/commodity price crunch.

Although the low share price is understandable, it seems excessive. Fact of the matter is, the midstream energy industry has performed quite a bit better than is reflected in their share prices and performance. Several of the fund's largest holdings have seen reasonably stable revenues and earnings these past few months, and have even seen distribution hikes.

As an example, both Enterprise Products Partners (EPD) and Magellan Midstream Partners (MMP) both hiked their distributions last year, both by about 1%. This was a nominal hike, but a hike nonetheless. Both companies have also seen their share prices decrease by more than 20% in the past year.

Data by YCharts

As mentioned previously, the above is understandable. Energy prices are down and investors are bearish about the industry. Still, the market seems to be overreacting, as the actual financial performance of both companies is somewhat better than implied by their share price movements. The same applies to MLPA.

In my opinion, continued economic recovery, combined with rising energy prices should lead to higher share prices, and outstanding market-beating returns for shareholders.

MLPX Comparison

Finally, I wanted to do a quick comparison between MLPA and the Global X MLP & Energy Infrastructure ETF (MLPX), a similar fund by the same index provider. I previously covered MLPX here.

MLPX focuses on the midstream energy industry, and invests in both MLPs and more traditional C-corps. The latter tend to be larger and of higher quality than MLPs, and so are comparatively safe companies and investments.

As such, MLPX has a lower yield, risk, and potential return when compared to MLPA. Both are reasonable choices, with MLPA being more reasonable for more bullish investors, and MLPX being more appropriate for those who are more risk-averse.

In my opinion, MLPA is looking quite attractive at these prices and valuations, but MLPX is the better long-term choice, due to its more diversified and higher-quality holdings.

Conclusion

MLPA's strong 10.8% distribution yield and possibility of substantial capital gains make the fund a buy. At the same time, the fund's low-quality holdings, excessive commodity price exposure, and its risky distributions mean that the fund is really only appropriate for more bullish investors wishing to speculate on the energy industry. More risk-averse or income investors should strongly consider other funds.

Analyst’s 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.

This article was originally published to members of the CEF/ETF Income Laboratory on January 17 2021.