Low Natural Gas Prices And Interest Rates: 2 Opposing Forces To Keep MLPX Rangebound

ETFS

Energy companies have taken a beating to start off the year, with the double whammy of plunging crude oil (USO) and natural gas (UNG) leading to the energy sector (XLE) having the worst performance (-8% YTD) among all S&P sectors. The MLP & Energy Infrastructure ETF (MLPX) could not escape unscathed either with a -3% YTD drop due to its high correlation to falling natural gas prices:

Source: WingCapital Investments

That being said, further downside appears limited with trailing dividend yield rising back towards the key 6%, which historically served at a strong support since its inception:

Source: WingCapital Investments

With bond yields pinned near record lows, MLPX’s lofty dividend yield certainly looks attractive to investors craving for yield. However, MLPX has been unable to penetrate above the multi-year downtrend due to questionable growth prospects and sustainability of the dividend payout in the face of a challenging natural gas industry. That said, there is reason to be optimistic with MLPX’s TTM dividend payout trending higher for 2 years in a row albeit at a slow pace:

Bifurcation Between The “Big 4” Vs. The Rest

Deep diving into MLPX’s top 15 holdings, which make up 85% of its exposure, we notice that the 4 largest names have accounted for bulk of the dividend growth in MLPX in the past 3 years as shown below. The fundamental divergence is reflected in their 52-week price performance, which averaged 20% vs. negative for the rest of the top 15 holdings.

SymbolName% Weight52-Week

3 Year Dividend Growth Rate

Dividend Yield (FWD)
TRPTC Energy Corp9.30%31.09%9.74%4.14%
ENBEnbridge Inc9.05%13.13%11.53%5.56%
KMIKinder Morgan Inc Class P9.04%20.01%23.85%4.70%
OKEONEOK Inc8.04%18.51%12.79%4.87%
WMBWilliams Companies Inc6.79%-18.97%-3.28%7.03%
PPLPembina Pipeline Corp6.66%18.00%-5.52%4.99%
ETEnergy Transfer LP4.87%-12.06%2.29%9.67%
TGETallgrass Energy LP Class A4.80%-7.54%33.94%9.59%
EPDEnterprise Products Partners LP4.40%-2.81%3.35%6.55%
TRGPTarga Resources Corp4.30%-11.75%0.00%9.69%
PAGPPlains GP Holdings LP Class A4.30%-24.67%-16.79%8.19%
LNGCheniere Energy Inc4.26%-6.29%
MMPMagellan Midstream Partners LP3.63%0.64%7.53%6.42%
ETRNEquitrans Midstream Corp3.14%-50.91%17.51%
AMAntero Midstream Corp2.54%-53.05%19.89%
Top 435.43%20.82%14.49%4.81%
Rest of Top 1549.69%-11.91%1.71%8.22%
Top 1585.12%1.71%7.03%6.80%

Source: Seeking Alpha

Although the non-top 4 holdings boost much higher dividend yield collectively, the risk of dividend cuts is also most vulnerable in 4 out of those names, namely TGE, TRGP, ETRN, and AM, which have forward distribution coverage ratio uncomfortably close to 1.0. The uncertainties on future payouts along with recent cuts certainly explain the massive underperformance in many of the holdings outside of the “Big 4”.

Source: TIKR.com, WingCapital Investments

Solid Interest Coverage Offsets High Leverage Ratios

The elevated debt levels have been another ongoing concern for MLPs, as witnessed by majority of MLPX’s top 15 names having net debt/EBITDA ratios above 4.0x:

SymbolName% WeightNet Debt / EBITDA20192020 EEBT / Interest Expense20192020 E
TRPTC Energy Corp9.30%4.975.023.012.77
ENBEnbridge Inc9.05%5.245.282.822.76
KMIKinder Morgan Inc Class P9.04%4.494.411.581.82
OKEONEOK Inc8.04%4.814.383.253.55
WMBWilliams Companies Inc6.79%4.494.431.371.58
PPLPembina Pipeline Corp6.66%3.973.935.704.68
ETEnergy Transfer LP4.87%4.474.502.292.40
TGETallgrass Energy LP Class A4.80%4.835.023.532.77
EPDEnterprise Products Partners LP4.40%3.323.333.884.09
TRGPTarga Resources Corp4.30%5.615.230.421.23
PAGPPlains GP Holdings LP Class A4.30%3.254.175.243.26
LNGCheniere Energy Inc4.26%9.527.040.501.13
MMPMagellan Midstream Partners LP3.63%3.123.154.844.34
ETRNEquitrans Midstream Corp3.14%1.792.972.132.96
AMAntero Midstream Corp2.54%3.413.454.123.35
Top 435.43%4.624.542.912.80
Rest of Top 1549.69%4.884.792.652.70
Top 1585.12%4.444.363.092.87

Source: TIKR.com, WingCapital Investments

That being said, as also illustrated above, the interest coverage ratios are adequately above 1.0 for the top 15 names except for TRGP and LNG. Not to mention with interest rates gravitated towards record lows, interest expenses are unlikely to rise as well. Indeed, the silver lining of persistently low commodity prices has been the lack of inflation in energy, which has helped perpetuate the regime of low interest rates:

Source: Federal Reserve Bank of St. Louis

Therefore, we do not expect the high leverage levels to have a significant negative impact on the MLPs in the current macro environment.

MLPX Most Likely To Remain Rangebound

All in all, MLPX has and will continue to face the two opposing forces in:

  1. Uncertainties in some of the holdings to generate growth and deliver the expected dividends on the heels of challenging fundamentals
  2. Favorable interest rate environment which keeps a lid on overleverage concerns and continues to attract yield buyers

We expect the two to be largely offsetting and lead to prices to continue whipsawing in a tight range. In fact, MLPX’s rolling 12-week trading range has averaged around 10% for much of the past 3 years:

Assuming the 10% range to continue in the next 12 weeks, MLPX will most likely be bounded between 11 and 13 during this quarter. Given MLPX’s rock-solid dividend payout and robust buying support to be expected upon dividend yield rising above 6%, a floor of 11 looks highly plausible. On the other hand, 13 will be a major hurdle on the upside given the unrelenting pressure on natural gas prices.

Enhance Yield Using Income Options Strategies

To take advantage of a rangebound environment, MLPX holders can look into selling March covered calls and cash-covered puts with strikes 13 and 11 respectively to generate income on top of the quarterly distributions. Though, the lack of open interest in MLPX’s options could present a challenge in getting robust execution prices:

Source: Optionistics

Assuming the last trade prices of 0.10 and 0.30 for 13 calls and 11 puts are accurate, we can collect up to a total of 0.40 premium should MLPX trade between 11 and 13 by March 20. The odds certainly look favorable given the above analysis, and the premium represents a 3+% income yield on top of the 1.5% distribution yield on a quarterly basis.

In summary, we anticipate MLPX to continue consolidating in a tight range with fundamental headwinds counterbalanced by positive tailwinds from a persistently low interest rate environment.

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: We may have options, futures or derivative positions on the above tickers mentioned

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