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Here's Why MLP ETFs Can Outperform Ahead

Oil ETFs like United States Oil ETF USO and United States Brent Oil ETF BNO slumped 6.8% and 4.2%, respectively, in the past three months (as of Nov 18, 2022), due to global recessionary fears and a likely fall in demand. A strong greenback has also been weighing on the broad-based commodities as the latter is priced in the U.S. dollar.

Although the fate of energy players is highly dependent on oil and gas prices, stocks belonging to midstream MLPs have lower exposure to volatility in commodity prices. This is because midstream players generate stable fee-based revenues since the transportation and storage assets are being booked by shippers for the long term.

Thus, their business model is relatively low-risk, signifying considerably lower exposure to both oil and gas price and volume risks. As a result, Energy and Pipeline - Master Limited Partnerships added 10.9% gains in the past three months against a 7% decline in the S&P 500.

Lure of Dividends

MLPs are known for their high-yielding nature as they do not pay taxes at the entity level and can thus pay out most of their income (more than 90%) in the form of dividends like the REIT firms. While most traditional income asset classes produced miniscule yields, MLPs lured investors with their higher payouts. The MLP segment yields a 7.86% annually versus 1.61% dividend yield offered by the S&P 500.

Fed Rate Hike Pace to Slow Down Ahead?

Yes, MLPs underperform in a rising rate environment as these have to depend on the debt market to finance their operations or fresh projects. Naturally, higher rates amid the Fed tightening cycle would cut back their profitability. But investors should note that many MLPs use a fixed rate debt for their borrowings.

Moreover, the Fed is likely to slower its rate hike pace in the coming days as inflation is showing signs of easing. Atlanta Federal Reserve President Raphael Bostic said recently that he is ready to "move away" from three-quarter-point rate hikes at the Fed's December meeting and feels the Fed's target policy rate need rise no more than another percentage point to combat inflation.

"If the economy proceeds as I expect, I believe that 75 to 100 basis points of additional tightening will be warranted," Bostic said in remarks prepared for delivery at the Southern Economic Association, as quoted on Yahoo Finance. If the rate hike momentum slows down, recessionary fears will also go away slowly thus boosting oil prices.

MLPs Are Undervalued than the S&P 500

Price/book ratio of MLP stands at 2.86X (versus 5.17X possessed by the S&P 500). Price/Sales of the MLP segment stands at 0.77X (versus 2.58X possessed by the S&P 500). Forward P/E ratio of the segment is 12.59X versus 17.56X offered the S&P 500.

Return of Equity of the segment is 31.09% versus 17.91% of the S&P 500. Return-on-asset of the segment is 9.94% versus 7.24% of the S&P 500.

MLP Industry’s Financials Look Steady Against the S&P 500

The MLP segment has a debt-equity ratio of 0.07X versus 0.61X of the S&P 500. Current ratio of the segment is 2.25X versus 1.23X possessed by the S&P 500. Not only that, MLP stocks are not much volatile as they have a beta of 1.05X versus 1.06X possessed by the S&P 500.

Strong Industry Rank

The dual benefits of decent oil prices and a high-yielding nature might favor MLP ETF investing at the current level. Investors should note that the Zacks Industry Rank of the energy and pipeline MLPs is in the top 37% (at the time of writing).

ETF Choices

Below, we highlight a few MLP ETFs that were in the green in the past month and have decent dividend yields.

Global X MLP & Energy Infrastructure ETF MLPX – Up 10.1% Past Month; Yields 5.54% annually

InfraCap MLP ETF AMZA – Up 9.25% Past Month; Yields 9.37% annually

First Trust North American Energy Infrastructure Fund EMLP – Up 8.53% Past Month; Yields 3.45% annually

Alerian MLP ETF AMLP – Up 7.57% Past Month; Yields 7.99% annually

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

United States Oil ETF (USO): ETF Research Reports

Alerian MLP ETF (AMLP): ETF Research Reports

United States Brent Oil ETF (BNO): ETF Research Reports

InfraCap MLP ETF (AMZA): ETF Research Reports

Global X MLP & Energy Infrastructure ETF (MLPX): ETF Research Reports

First Trust North American Energy Infrastructure ETF (EMLP): ETF Research Reports

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Zacks Investment Research