What is Happening?
The energy sector’s outperformance is being driven by more than geopolitical red flags.
While energy (S&P Energy Index S5ENRS) has outperformed the S&P 500 by nearly 10 percent this year, since mid-2021 -when energy had finally recovered to pre-COVID levels- it has outperformed by about 70%. (Source: Bloomberg)
Over this same time period, pipelines/midstream (Alerian MLP Index AMZ) have also outperformed the S&P 500 by about 50% and utilities (S&P 500 Utility Index S5UTIL) have lagged – by about 15% – but that trend seems to have reversed. (Source: Bloomberg)
Finally, over this same time period, clean energy stocks (S&P Clean Energy Index SPGTCED) have underperformed the S&P 500 by over 60%. (Source: Bloomberg)
Exhibit 1 – Performance of Energy Subsectors vs the S&P 500 from June 30, 2021 to March 28, 2024
Source: Bloomberg as of March 28, 2024.
Here are the drivers of these trends.
Yield
Higher yields for the companies in S5ENRS have contributed about 15 of the 70 percentage points of outperformance. For pipelines/midstream, just over half of the outperformance has come from higher dividend yields.(Source: Bloomberg)
Earnings Growth & Valuation
Since mid-2021, oil prices are up only about 12% but 12-month forward earnings estimates are up about 138% for S5ENRS and 33% for AMZ. Earnings growth for the much-maligned utility sector has been 20% vs 24% for the S&P 500, but valuation has dropped by 14% for utilities as the loose connection between a few (but large) utilities and clean energy has dragged down the whole group.
Exhibit 2 – Changes in Earnings and Valuation – June 30, 2021 to March 28, 2024
Source: Bloomberg as of March 28, 2024.
Looking Forward…
Valuation
While the valuations of the stocks in our portfolio are extremely low when compared to history, and other sectors with comparable earnings growth stability and predictability, the sum of the yield and growth of our portfolio is over 10% without any recovery in valuation. (Source: Bloomberg)
Exhibit 3 – Valuation of the Energy and Energy Infrastructure Indices
Source: Bloomberg as of March 28, 2024
Nonetheless, the cyclical energy and energy infrastructure segments of the industry have experienced valuation declines of about 50% over the last 10 years as the market doubts the future of conventional energy assets. This, despite global oil and natural gas demand continuing to hit new highs every year (Read: EIP Insights on Supply & Demand).
For electric utilities, sentiment may finally be shifting as U.S. electric power growth estimates have tripled recently due to the advent of AI data centers, reshoring, electrification and the waning impact of lighting and appliance efficiency gains. (Read: Nuking the AI Data Centers)
The supply demand imbalance for electric power could become acute. For the first time in over 40 years industrial consumers, mostly big tech, are looking at self-generating reliable and clean power. Companies like Amazon are securing long-term power agreements with specific nuclear plants that are co-located with their datacenters instead of just buying the power off the grid. Why? Because nuclear power is zero-carbon and 100% reliable.
As the facts playout that wind, solar, batteries and electric vehicles will not flip conventional energy demand growth into the negative column anytime soon, sentiment is shifting. (Read: Economic Shutdown in the Energy Transition)
Earnings Growth
Regardless of valuation, earnings growth of our portfolio companies remains stable and uncorrelated to the broader economy averaging around the mid to upper single digits, which is in-line with the long-term earnings growth of the S&P. And stable earnings mean higher dividend payout ratios.
The projected growth in demand from megatrends like datacenters and reshoring means we need increasing amounts of infrastructure, generation, and all things that feed that generation. Coal plants in the U.S. we believe, will continue to close due to age and no utility wants to build a new coal plant any more than they want to build a new nuclear plant. That leaves natural gas and renewables, the only two sources of power that will grow according to the industry’s 5-year plans.[i] But it also means growth for regulated utilities who are ultimately responsible for grid reliability, profitable renewable developers and natural gas infrastructure that will feed growing natural gas fired power generation.
Clean Energy
Clean energy stocks are suffering from the same thing conventional energy stocks suffered from 10 years ago: too much capital spending. In this case the capital spending is being driven by government subsidies. While the technologies may be zero carbon, they must compete in our un-regulated free-for-all energy markets. Costs and performance matter and that is why their earnings expectations keep falling.
Final Thought
While the strength of the fundamentals in conventional energy infrastructure, in particular, and energy, in general, have been improving for over three years, it has largely gone unnoticed by generalist investors. The alarm of recent geopolitical events and the now evident energy requirements of AI driven data center demand just might get generalists to take a look. And once they do, they will likely notice these other attributes as well.
This information is based upon EIP’s opinion which may change at any time and without notice. The information provided above is based on data obtained from third party publicly available sources that EIP believes to be reliable, but EIP has not independently verified and cannot warrant the accuracy of such information. In providing the information, EIP has made several assumptions that if changed, materially affect the information and conclusions provided. Nothing in this article is an offer to sell or buy a particular company or invest or refrain from investing in a particular industry.
S&P 500 Index: A capitalization-weighted index of 500 stocks. This Index is designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
iShares Global Clean Energy (ICLN) ETF is an exchange-traded fund incorporated in the USA. The ETF tracks the performance of the S&P Global Clean Energy Index. The ETF holds energy, industrial, technology, and utilities stocks that can be predominantly classified as mid cap. The ETF weights these holdings using a market capitalization methodology. EIP defines “Utilities & Renewables” as companies identified under GICS Sub-Industries that include: Multi-Utilities, Electric Utilities, and Renewable Electricity. “Other“ category is all other GIC Sub-industries.
Energy Select Sector SPDR Fund (XLE) is an exchange-traded fund incorporated in the USA. The ETF tracks the performance of the Energy Select Sector Index. The ETF holds large-cap U.S. energy stocks. It invests in companies that develop & produce crude oil & natural gas, provide drilling and other energy related services. The holdings are weighted by market capitalization.
Alerian MLP Index (AMZ): A composite of the most prominent energy master limited partnerships, whose constituents represent approximately 85% of the total float-adjusted market capitalization, calculated by Standard & Poor’s using a float-adjusted market capitalization methodology on a price-return basis.
Standard and Poor’s 500 Utilities Index (S5UTIL) is a capitalization-weighted index. The parent index is SPXL1. The index was developed with a base value of 100 as of December 30, 1994. This is a GICS Level 1 Sector group. Intraday values are calculated by Bloomberg and not supported by S&P DJI, however the close price in HP<GO> is the official close price.
Standard and Poor’s 500 Energy Index (S5ENRS) is a capitalization-weighted index. The index was developed with a base level of 10 for the 1941-43 base period. The parent index is SPXL1. This is a GICS Level 1 Sector group. Intraday values are calculated by Bloomberg and not supported by S&P DJI, however the close price in HP<GO> is the official close price calculated by S&P DJI.
S&P Global Clean Energy Index (SPGTCED)is designed to measure the performance of companies in global clean energy-related businesses from both developed and emerging markets, with a target constituent count of 100.
Standard and Poor’s 500 Economic Sectors Index (SPXL1) is a capitalization-weighted index. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941-43 base period.
The indices have not been selected to represent an appropriate benchmark with which to compare an investor’s performance. An index is unmanaged, does not incur fees or expenses and an investment cannot be made directly in an Index.
[i] Wolfe Research
Energy Income Partners, LLC
Energy Infrastructure and MLP Income Strategy – Retail SMA
Compliance Statement
Energy Income Partners, LLC (EIP) claims compliance with the Global investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Energy Income Partners, LLC (EIP) has been independently verified for the periods October 2003 through December 2023. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The Energy Infrastructure and MLP Income Strategy – Retail SMA composite has had a performance examination for the periods January 2010 through December 2023. The verification and performance examination reports are available upon request.
The Composite
The composite includes all fee-paying discretionary portfolios that seek to generate above-average returns and yield by investing in Publicly Traded Energy Master Limited Partnerships (MLPs) and MLP affiliates, Utilities, Yield Corporations (YieldCos) and Energy Infrastructure Real Estate Investment Trusts (REITs). The composite was created in January 2010. The portfolios are based on an institutional model, however, are managed for turnover, quantity of K-1s generated and small position sizes.
The Firm
EIP is an independent investment management firm established in 2003. In November 2004, EIP became affiliated with Pequot Capital Management until August 2006, at which time the firm re-established its independence as EIP. In June 2006, EIP registered as an independent investment advisor with the United States Securities and Exchange Commission. EIP manages and sub-advises a variety of funds and portfolios whose primary investments are concentrated in the energy industry. A complete list and definition of EIP’s composites is available upon request.
The Benchmark
The benchmark is the Alerian MLP Total Return Index (AMZX) which is a composite of the most prominent MLPs calculated by Standard & Poor’s using a float-adjusted market capitalization methodology.
Valuation and Performance Returns
The assets are valued and performance calculated in United States dollars. Portfolio returns include the reinvestment of interest, dividends and other earnings. Returns are presented gross and net of fees. Gross returns for bundled fee accounts are shown as supplemental information and are stated gross of all fees; for some bundled fee accounts the gross return is after transaction costs. Net returns are reduced by all actual fees including performance incentive fee and transaction costs incurred. The financial advisor fee is a bundled fee determined and collected directly by the financial advisor. Common services covered by the bundled fee may include (but are not limited to) a combination of transaction, advisor, brokerage, custody, research, reporting, and administrative costs, as well as other services provided by the sponsor under the program. To determine what services are covered under the portfolio’s bundled fee, the portfolio holder should contact their financial advisor.
Fee Schedule
The standard fixed investment management fee is .75% per annum. The investment financial advisor fee ranges up to 2.75% per annum and may vary by portfolio.
Composite Dispersion & Standard Deviation
Dispersion is measured using the asset weighted standard deviation method which measures the consistency of composite performance with respect to the individual portfolio returns. Portfolios in the composite less than a year are not included in the dispersion calculation. Standard deviation is a measure of price variability (risk) over a period of time. A higher standard deviation indicates more variability in returns from month to month. The three-year annualized ex-post standard deviation of the composite is not presented for the years 2010 and 2011 because 36 monthly returns are not available. Gross of fees returns are used to calculate the presented risk measures.
Other Disclosures
Results are based on fully discretionary portfolios under management, including those portfolios no longer with the firm. Portfolios that have been traded for tax loss harvesting are considered non-discretionary and are not included in the composite temporarily. Past performance is not indicative of future results. There can be no assurance that a purchase of the securities in this portfolio will be profitable, either individually or in the aggregate, or that such purchase will be more profitable than alternative investments. Policies for valuing investments, calculating performance and preparing the GIPS Report are available upon request. The firm’s list of pooled fund descriptions for limited distribution pooled funds is available upon request.
GIPS® is a registered trademark of the CFA Institute. The CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.
To request further information, please contact Energy Income Partners, LLC at 203-349-8232 or at ir@eipinvestments.com.