Investors Continue To Rotate Into Energy

The pipeline sector continued on its tear last week. The catalyst was Pfizer’s (PFE) vaccine announcement a month ago, but cheap valuations have drawn increasing attention as prices have risen. The buybacks announced by several companies added further support.

For many months, we’ve argued that the biggest problem with the sector was negative sentiment. Since peaking in 2014, midstream energy infrastructure has lagged the S&P500 significantly. The industry began to acknowledge investor criticism of over-investment back in 2018. That’s when growth capex peaked. Since then, the path to growing free cash flow has been clear – but sentiment is often the last piece to fall in place.

Rising stock prices are starting to do that. This is persuading investors that what appears cheap perhaps really is. We are seeing it in our own business, where inflows have returned and investors are increasingly prepared to commit capital. The energy sector ETF XLE is on track for a record year of AUM growth.

Energy is part of the broader shift from technology to value, including small cap. The widely-watched QQQ/IWM ratio solidly crossed its 200-day moving average to the downside last month, and has continued its new trend.

Since the beginning of October, the American Energy Independence Index has rallied 32%. At –8% YTD, it’s not inconceivable that it could claw back its remaining losses for the year. At the end of March, it had lost more than half its value over the prior three months.

So it’s worth pausing to examine valuation.

The components of the AEITR still yield 7.5% — still sufficiently high to suggest healthy skepticism regarding sustainability. Yet all companies except for Energy Transfer paid quarterly dividends at least as high as before. We calculate that payouts are now covered almost 2X by Distributable Cash Flow (DCF).

Free Cash Flow (FCF) should come in at $23BN for the year, up from $8BN in 2019. We entered 2020 expecting FCF to double, and by May reaffirmed that forecast (see Pipeline Cash Flows Will Still Double This Year).

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