ENFR: Strong Midstream Energy ETF, Good 5.4% Yield (NYSEARCA:ENFR)

ENFR – Overview and Investment Thesis

The Alerian Energy Infrastructure ETF (NYSEARCA:ENFR) is a midstream energy index ETF, focusing on midstream energy corporations. ENFR’s investment thesis rests on the fund’s:

• Comparatively safe midstream energy holdings, with relatively stable revenues and resilient business models
• Good, growing 5.4% dividend yield, backed by stable revenues and cash flows
• Cheap valuation, with the fund trading at a sizable discount to the S&P 500

Let’s have a closer look at each of the points above.

Comparatively Safe Midstream Energy Holdings

ENFR is a midstream energy index ETF, tracking the Alerian Midstream Energy Select Index. It is a relatively simple index, including relevant midstream energy corporations and MLPs localized in either the U.S. or Canada. Midstream companies are those focusing on gathering, processing, liquefaction, transportation, and storage of energy products, including crude oil, natural gas, LNG, and others. It is a modified market-cap weighted index, with caps meant to ensure compliance with regulatory standards. ENFR is not liable for corporate taxes, nor do investors have to file a K-1 form.

ENFR’s portfolio seems reasonably well-diversified for a midstream energy fund, with investments in 25 companies, and with some industry/country diversification.

ENFR is reasonably well-diversified for a midstream energy fund. It does not provide diversified exposure to the broader equity market, like an S&P 500 index fund or similar. ENFR focuses on a niche sub-segment, midstream, within a niche industry, energy, with much less diversification than most equity funds. As such, I would keep any investment in ENFR small and would make sure to not significantly overweight energy in my portfolio.

ENFR’s midstream energy companies are comparatively safe, stable companies, due to their business models. The average ENFR holding transports oil from one location to another. Transporting crude oil from Alberta, in Western Canada, to refineries in the Eastern United States is a typical midstream energy activity. Enbridge (ENB) and Enterprise Products Partners (EPD) are two of the largest midstream energy companies in the world and representative of the industry.

Midstream energy companies charge their customers for use of their pipelines. Canadian oil producers might buy pipeline access from Enbridge to ship crude from Alberta to refineries on the Eastern Coast, for instance. In some cases, ideally most, fees are flat, and not dependent on energy prices or volume. For Enbridge, these account for around 98% of the company’s EBITDA, all but ensuring stable revenues and earnings for the company.

The larger, blue-chip midstream energy companies have similar characteristics to Enbridge, and so have much more stable revenues, earnings, and cash flows than energy producers. As an example, compare Enbridge and Enterprise Products Partners revenues and EBITDA during COVID with that of Exxon (NYSE: XOM) and Chevron (NYSE: CVX). Enbridge and EPD’s financials were much more stable, and at least some of the volatility was caused by other factors (foreign currency issues and the like).

Midstream energy companies are much more stable and resilient than the average energy company, a significant, straightforward benefit for investors.

On a more negative note, I’ve found that the market sometimes perceives midstream to be riskier than it is, leading to higher-than-expected volatility and drawdowns. ENFR saw broadly similar losses to broader energy indexes at the start of COVID, although it did recover a bit more rapidly. Share prices declined by more than fundamentals, based on the above, and in my opinion.

Notwithstanding the above, due remember that fundamentals matter, even though markets do not always reflect these. The fact that Enbridge and EPD can sustain their revenues and earnings better than Exxon or Chevron is a real, tangible, and significant advantage of the former over the latter. Which brings me to my next point.

Good, Growing 5.4% Yield

Midstream energy companies tend to distribute excess cash-flows to shareholders, with most of these sporting good yields. Some sport outstanding yields too, generally the smaller, riskier ones. ENFR itself sports a 5.4% dividend yield, which is reasonably good on an absolute basis, and higher than the equity average.

ENFR’s dividend growth track record is quite strong, with fund dividends seeing double-digit CAGR since inception, and for the past twelve months. Dividends were flat from 2019 to 2022, due to the coronavirus pandemic, and as several midstream energy companies shifted to self-financing their CAPEX during these years, due to unfavorable financing (rates were high, valuations low).

On a more negative note, dividends were flat from 2019 to 2022, due to the coronavirus pandemic, and as several midstream energy companies shifted to self-financing their CAPEX during these years, due to unfavorable financing (rates were high, valuations low). Dividend growth has resumed these past two years and a strong pace.

ENFR’s good, growing 5.4% dividend yield is a significant, straightforward benefit for investors. Importantly, these are not dependent on investor sentiment, but on financial fundamentals, a distinction which is of great importance in the energy industry.

The market might not care that ENFR’s underlying holdings have somewhat stable revenues and earnings, but these help stabilize the fund’s dividends regardless. ENFR’s dividends were only down 9% during the pandemic, much less than the 24% share price decline.

Cheap Valuation

Energy is currently the cheapest equity industry, with a 10.8x PE ratio. Energy trades at a moderate discount to its historical average, significant discount relative to the S&P 500.

ENFR itself also trades with a significant discount to the S&P 500, slight premium to broader U.S. energy equity indexes.

ENFR’s cheap valuation benefits investors in two key ways.

First, cheap valuations can always improve or normalize, giving rise to capital gains. For a fund like ENFR, gains could be quite high, an important, but uncertain, benefit for investors. Energy stocks have, in fact, seen their valuations improve these past few years, leading to significant capital gains. Valuations bottomed out sometime during 2020, due to the pandemic, and have improved since. ENFR has seen marginally higher capital gains since mid-2020, and significantly higher total returns (remember the dividends).

Performance above includes the recovery from the pandemic, which was something of an outlier. Performance has been incredibly strong since early 2022 too, and that excludes the pandemic completely.

On a more negative note, capital gains have been incredibly inconsistent. As an example, ENFR’s share price was mostly flat during 1H2023, even as the S&P 500 rallied.

In any case, ENFR’s cheap valuation has led to significant capital gains in the past and could lead to further gains moving forward. Gains are anything but certain, as these are dependent on investor sentiment, which is fickle and sometimes irrational. At the very least, the market is less bearish on energy than before.

ENFR’s cheap valuation also boosts the impact of dividends and buybacks, another important benefit for investors. Specifically, the fund trades with a 5.4% dividend yield at current prices and valuations. If valuations rose to the S&P 500 average, yields would drop to 3.5%. That 2.0% spread is due to ENFR trading with a cheap valuation. Valuations also increase the impact buybacks have on EPS, quite prevalent in the energy industry. These are both important benefits for shareholders and are not dependent on investor sentiment.

ENFR – Performance Analysis

ENFR’s long-term performance track record is quite mediocre, with the fund significantly underperforming the S&P 500 since inception. Performance was greatly impacted by timing, with the fund being created in late 2013, a few years prior to a significant, long-lasting commodity price crunch. There were significant gains in prior years too, but the fund was created too late to realize these.

On a more positive note, ENFR’s returns have markedly improved these past few years. The fund has outperformed for the past three years or so, and for several shorter periods of time too, including during 2022, and the second half of 2023. It has also significantly outperformed since I last covered the fund, in late 2021.

Improved performance matters insofar as it shows that the fund is able to outperform and that current conditions are at least somewhat favorable to this.

It also matters insofar as it is evidence of its current investment thesis/industry conditions. ENFR’s returns were weak when oil was cheap, energy companies were expensive, and the industry focused on CAPEX. ENFR’s returns have much improved since oil prices improved, valuations plummeted, and the industry shifted towards returning cash to shareholders. Current conditions have led to very strong returns for ENFR these past few years and will, in my opinion, continue to do so.

Conclusion

ENFR’s comparatively safe midstream energy holdings, good, growing 5.4% dividend yield, and cheap valuation, make the fund a buy.