Alma Recurrent Energy Infrastructure Income Fund

Market Review and Outlook

Since 2018, Wall Street has modelled Midstream as a low-growth / no-growth industry – but growth has persisted
As Midstream experienced a painful multi-year downturn from 2014 through 2020, many analysts’ cash flow growth forecasts began to reflect the painful downturn in stock prices. During and even after COVID, Wall Street forecasts for Midstream EBITDA growth have been anemic – reflecting concerns about lower Shale productivity and the impact of the Energy Transition on oil and gas demand. This “lack of growth” has been reflected in valuation multiples which remain well below pre-COVID levels. Interestingly, actual financial results have dramatically exceeded expectations in the past 5 years, reflecting an industry that has achieved meaningful operating leverage and margin expansion from assets which only became recently operational.

On a cumulative basis, Midstream industry EBITDA has expanded by $31bn, or nearly 50% – approximating $100bn on an annual basis today. If we were to look at the cumulative expectations for year-over-year EBITDA growth published by Wall Street analysts over that time, we would see $9bn of cumulative EBITDA growth. In other words, actual cumulative EBITDA growth has more than tripled analyst expectations over the past 5 years.

A skeptical reader might ask, “Aren’t Wall Street estimates made to be beaten?” – but there’s more to the story
We appreciate the skepticism that comes with midstream and energy investing, especially as the sector remains largely out of favor among investors. A possible reply might be, “They beat analyst estimates – so what?” And that question is fair in anticipating the fact that growth isn’t noteworthy simply because it exceeded Wall Street’s forecast – it’s only noteworthy if the growth is generated in a capital-efficient way. And here again, we see that Midstream is outperforming expectations – while EBITDA is sometimes subject to “sandbagging,” management teams generally do not sandbag capital expenditures. And we see again that Midstream is beating Wall Street capex estimates even while growing cash flow.

Midstream was exceeding capex forecasts – effectively running over budget on growth projects – by billions of dollars annually during 2018-2020. The result was a free cash flow outlook that consistently disappointed. Since 2021, Midstream industry capex has met or fallen below forecasts, with over $2bn in excess free cash flow coming from YTD 2023 capital discipline alone.

Even with large-cap Canadian midstream names outspending, most growth is being supported by near-maintenance capex
We noted two months ago that Canadian large cap midstream companies had maintained high capex business models, and their stock performance has suffered considerably as a result. But even with significant Canadian capex burdens, the Midstream sector broadly remains highly disciplined. Below, we take Wall Street forecasts out of the equation and compare the companies to themselves. As recently as 2018, Midstream capex was 2.7x greater than book depreciation. As spending has dropped by >$20bn in the last 5 years, capex today approximates 125-135% of book depreciation, despite meaningful economy-wide cost inflation in the last 3 years.

In our recent white paper, we noted that midstream earnings yields were double-digit, and meaningfully above REIT or utility earnings yields. Importantly, with midstream capex approximating book depreciation levels, this means that Midstream free cash flow yields are also likely to be double-digit – compared to a sector-wide dividend payout that remains approximately 6% to 7% today. With double-digit free cash yields and persistent EBITDA growth (even in a lower capex environment), Midstream continues to defy forecasts of obsolescence and decline even despite valuations that reflect a thus-far illusory terminal value risk.

Fund

During the month of October 2023, the Alma Recurrent Energy Infrastructure Strategy generated net returns of -2.35%, lagging the Alerian MLP Index’s (AMNA) -0.34% return by 2.01%.