Lead-Lag Live

Pipeline Powerhouses: Mastering MLP Investments

• Michael A. Gayed, CFA

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Dive into the often misunderstood world of Master Limited Partnerships (MLPs) with Jay Hatfield of Infrastructure Capital as he clarifies exactly what makes these unique investment vehicles tick. Far from simply being "pipeline stocks," MLPs represent a sophisticated investment opportunity combining advantageous tax structures with stable cash flows and attractive yields.

Jay breaks down the fundamental economics driving pipeline companies, explaining why they remain remarkably resilient even during periods of energy price volatility. Unlike direct energy producers, these infrastructure businesses operate primarily through long-term contracts and acreage dedications, creating predictable revenue streams regardless of short-term commodity fluctuations. Currently yielding around 7% with 5% annual distribution growth, today's MLPs target double-digit total returns while maintaining conservative financial policies.

The conversation highlights how natural gas infrastructure stands at the intersection of several major global trends. As electricity demand surges from AI development, electric vehicles, and broader electrification, natural gas remains essential for grid stability—something even renewable-heavy regions like Spain and Portugal have learned through experience. Meanwhile, policy shifts under the Trump administration supporting LNG exports create substantial growth runways for companies transporting America's abundant natural gas resources to global markets hungry for cleaner energy alternatives.

Perhaps most compelling for investors is the portfolio diversification MLPs offer, showing only 60-70% correlation to broader markets while providing meaningful income. The industry's evolution over recent years has created stronger, more resilient companies with national operations, investment-grade balance sheets, and sustainable distribution policies. For retirement-focused investors especially, these characteristics make MLPs worth serious consideration as part of a balanced portfolio strategy.

Ready to explore how MLPs might fit into your investment approach? Visit infracapfunds.com to learn more about AMZA and other specialized ETFs designed to capture opportunities in this dynamic sector.

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Speaker 1:

This will be a good conversation. This is going to be a little bit different. We're going to do more of an educational back and forth around what exactly MLPs are and where there could be some interesting investment opportunities going forward in the space. My name is Michael Guyatt, publisher of the Lead Lag Report. Joining me here is Jay Hatfield of Infrastructure Capital. Infrastructure Capital is sponsoring this podcast, jay. We've done a number of these conversations in the last couple of months here, but I want to make this very much focused on the MLP space, because this is kind of a big specialty of yours and I don't know if that many people really understand what MLPs are. So let's go very basic and explain what exactly an MLP is.

Speaker 2:

Well, so it stands for Master, limited Partnership, and a limited partnership is, from a tax perspective, a past serenity, so you get the direct tax benefits that their companies produce. Master means it trades on stock exchange, and so that's particularly attractive for asset-intensive businesses that are expanding and can use accelerated depreciation to shelter their income. You know, that's the advantage of it. The disadvantage is there's something called a K-1. So that's a partnership return and that's often burdensome for, particularly if you have relatively small MLP holdings. And so we do with our ETF AMZA. We are a corporation, so we get in all the K-1s, file them and then deliver a 1099, which is what you get from normal companies, and that cleans up everybody's tax reporting. That's why AMZA is very popular.

Speaker 1:

And this is primarily in the energy space. What is it about the energy sector that lends itself towards the MLP structure?

Speaker 2:

Well, that was one of the original carve-outs for doing mass limited partnerships. There was, I mean, of course, if there was just an unlimited ability to do it, then most companies would convert to master limited partnerships, or at least theoretically. I'm not sure they would now, but so they were limited to energy infrastructure and energy. So what that means is basically a lot of times just them, as referred to them as pipeline companies. So they're natural gas pipelines, which is the biggest growth area, which you can talk about later, more whale pipelines and what's called refined products, which is just gasoline diesel jet fuel, and then also there's another segment that most large MLPs have, which is upstream processing of natural gas and liquids, and then there are some companies that have natural gas export facilities. So it's really the entire value chain in energy infrastructure, but does exclude the actual production of the hydrocarbons.

Speaker 1:

You mentioned pipelines and growth there, and I'm going to assume that relates to some of the policies and views that Trump has as part of that. But let's get into that a little bit, because I think when people think about sectors right very top down, they think in terms of homogeneity, right. Things are kind of co-moving. In a similar way, pipelines aren't really as tied, uh, to the price of oil as other parts of the energy space what happens is that there's contracts oftentimes and so all the production coming out of wells needs to be transported on pipelines.

Speaker 2:

So we both have contracts and once a well is drilled it's going to be pumped, so it's not really very dependent on incremental production. Very dependent on incremental production and also within a band, say, $50 to $70, the major oil producers are going to continue to even drill new wells because they've already planned for it. They have the capital to do it. So of course you know we're on negative $30 oil. That was bad for production. But within normal bands MLPs have strong operations and in a way too, since they do have refined products, pipelines. If oil prices come down, gasoline prices come down and there's more demand for the refined products. Even if there's a little less production, the rig now the big driver is, and there's a good example of why you want this in Spain and Portugal. But the only reliable way to generate electricity and to stabilize the grid is to have natural gas, because you can cycle it. It's called cycling, so in other words you can turn it on and off like a light switch. If you can't do that with a nuclear power plant, it takes like five days to bring it up. Coal-fired power plant probably two to three days, but natural gas you can just click the switch, it comes on. There's no startup issue. So you need that to stabilize the grid.

Speaker 2:

And, as we're finding out, there's limited opportunities to develop renewables. Not that we can't, but you can't put them in Manhattan, you don't really want them in the Northeast, for solar, at least Wind is very heinous, for environmental reasons, basically, and NIMBY reasons. So there's a limit. I'm a big renewables fan, but there's a limit to how much you can do. So if you have big electricity demand increases coming from AI, electric cars, electrification, population growth, you have to fulfill with natural gas. So that's a big opportunity.

Speaker 2:

And then, of course, the rest of the world needs natural gas, particularly Europe, but the rest of the world, natural gas, particularly Europe, but the rest of the world. And we have the lowest prices in the world because we have just way too much of it. So there's an export opportunity as well. So that's the big growth driver. And, ironically, really, when natural gas prices come down, it's actually good, because more gets burned for electricity and more gets exported and so more natural gas moves through the pipelines. So it's counterintuitive, it's not to say these stocks won't be hit when oil prices are down. But, it's important to remember, the fundamentals are static, in other words, their cash flow. Earnings and cash flow are not going to be impacted Within, like I said, within within calling $50 to $80. Like you know, if there were a $20, then production will start to drop. It won't be catastrophic right away, but it would be a headwind for these companies.

Speaker 1:

When you talk about these as in terms of contracts, how long live lived are those contracts? I mean, when do they actually renew? And then do the terms often change dramatically.

Speaker 2:

Usually, well, there can be a number of different types of contracts. But you can just have like a take-or-pay contract, but you have to transport a certain amount of hydrocarbons for a certain period, which roll over every five or ten years. Or what's more common is what's called an acreage dedication. So in order to induce the pipeline company this is particularly true for more upstream, like gathering systems to induce the company to build the gathering system, the producer will dedicate all the production from this certain amount of acreage into the pipeline. And then there's just other pipelines that may not have contracts but they're in just such great corridors, they know they're sort of naturally full, like if it's a corridor from Cushing to the Gulf of Mexico, to Houston Chip Channel, there's definitely going to be some contracts. But that could be something where it's just nominated because there's constant demand for moving those hydrocarbons down to the Gulf.

Speaker 1:

Typically in this space? What kind of yield ranges do we see?

Speaker 2:

Right now most of the MLPs are yielding around 7%, growing their distribution around 5% a year. So you can expect low, double-digit type returns, you know, because the yield plus the growth is your expected return. And it's been a big opportunity because the companies weren't as well structured about five years ago. They were structured as growth companies and so they weren't. They were paying out all their free cash flow as dividends. The problem with that is de facto.

Speaker 2:

Then you're relying on the capital markets for growth capital, and that can be great sometimes if the capital markets are fine, but terrible if they're bad and unreceptive to new issues, so they turn that on its head. Now they're only paying about 50% of their free cash flow out. The rest can be used for growth capital, but also for share purchases. So hedge funds were attacking these companies, hammering their stock prices down. And now when that happens, like in this dip, you know when the companies report and say, oh yeah, we did some share purchases, so they're actually happy when investors freak out about energy crisis and sell their stocks because it's more creative for them to buy back shares. So it's now a virtuous cycle and before it was a downward spiral, and ANZO was the first ETF that you launched.

Speaker 2:

First, yes, and it was one of the first active ETFs launched in the ETF world. It was launched 11 years ago.

Speaker 1:

So I'm curious what was the decision-making back then? Obviously you saw an opportunity in the space. When you look back with hindsight at the launch of AMSA, which has got almost half a billion in assets in that, were your expectations back then met? Are there still a lot more opportunities that maybe are coming because maybe they weren't met? Let's talk about that a little bit.

Speaker 2:

Was really driven by our deep expertise or, be more specific, my deep expertise in MLPs. So I used to be a energy utility an MLP investment banker, morty Stanley, and then also invested in MLPs at two large hedge funds, including Steve Cohen's 72 Point, and I launched my own MLP I founded with a client I co-founded really with the lead ceo called ngl energy partners. So we had taken that public in 2011 and so we're really leveraging off that deep expertise in mlps and our belief in the long-term prospects of the asset class and the attractive income and attractive growth and attractive tax characteristics, and so that was a good call because we did, we're able to raise a lot of capital relative to that.

Speaker 1:

Let's talk about pairing something like AMSA against a broader asset allocation and maybe pairing it specifically against a broader energy sector allocation. First of all, how does one think about even making a in quote call around MLPs?

Speaker 2:

Well the good news is you don't really have to. So MLPs are more rational than they used to be. Sometimes, when oil prices came down, they would actually be more volatile than regular energy stocks. So you know, like Chevron, exxon and other producers, like Fang, diamondback. So that was unfortunate and disconcerting as well, because you know investors, nobody really likes volatility, unless you're maybe an option trader or something. So you don't want to say I'm going to get good income but it's down 5% in a day. So now the stocks haven't completely disconnected from oil, but if oil stocks are down 2%, they'll be down 1%. So they're less risky than the upstream, which is appropriate and efficient, shows an efficient market because they don't have direct commodity exposure. Indirect, yes, but because of the throughput issue, and some MLPs have a little bit of commodity risk, but they've tried to get rid of that over time. They used to have contracts, some commodity components too, and so that's attractive. And then the other thing that's good about it so it's not fixed income as well. So we have two fixed income funds BNDES, pffa. They're less volatile than the market as a whole. But the good news now is that actually MLPs are less correlated to the market. They used to be kind of more correlated to market. Now they're less. They're about 60% correlated to the market, so it's a good offset.

Speaker 2:

If you have a whole bunch of tech stocks or S&P funds which implicitly are tech stocks, then oftentimes you'll see that MLPs are acting as a hedge. You know they might be flat and your tech stats are way up, but tech stats are way down. They might be up, and so it's a good diversifier and you add income at the same time and all of our funds. We do believe in income. You know, as on television on Fox Business and there's a lot of focus on retirement and we didn't get a chance to talk about though the income is the most reliable way to stabilize your portfolio when you're in retirement, because you're getting a good portion of your required draw out of like, even if it's just an rm like.

Speaker 2:

My mother-in-law has so much income that she doesn't need to sell her funds to make her RMD. She doesn't really need the money, but you do have to withdraw the cash. So it's a way easier way to manage portfolio and you don't end up locking in losses. When you have downturns, like we're in now, because of the fact that the cash is coming in automatically, you don't have to sell the fund Typically when you think about yield and income.

Speaker 1:

At least, I tend to think about lower volatility profile in general. Is it fair to say that AMSA can lower the overall beta of a portfolio less correlated than other subsegments of different sectors? Right now it is.

Speaker 2:

I say right now because you know things, in certain markets correlations change, Like if you do five-year regressions or you know statistical analysis on treasuries, you'd say, oh, they're correlated to the market and it's really just because of 2022, because we never had had such a fast increase in rates, which is one of the issues I have with the Fed is they're slow to reduce them and too fast to increase them, and so you had a situation where market would sell off because the bond was selling off. And so I would say that right now, MLPs that's just an example of how, where normally could be, the correlation might statistically be different. Now, statistically, MLPs are about, like I said, 65, 70% correlated in the market. So they do give you good diversification and just the only caveat and this happens with our fixed income funds too is the beta is sort of dynamic or the correlation is dynamic.

Speaker 2:

So if people are just liquidating all their portfolios like we even saw a big sell-off of mini bonds over the last month when we had what I call the chart of death or, I guess, liberation day I think it was liberation from your money day but you um see this sort of reduction in the value of being diversified because everything gets old. Like you thought, your mini bonds would be up and they're actually down, but for that just normal trending markets down. When trending upward, MLPs will give you diversification in your equity portfolio. I wouldn't treat them as fixed income so you're not as stable as like BMDS, PFFA. Because they're your senior to common, you get paid first and so you're inherently have a lower risk position than being in the equities of any company.

Speaker 1:

Really, how big is the universe, Meaning how many names are there in the space?

Speaker 2:

We have about 25 names in our portfolio and it is fairly concentrated just because the MLBs have been converting. We do have some regular corporations too, but they've been converting to corporations and they've been consolidating, which sounds bad but it's actually good because we're creating all these sort of impenetrable, long lasting companies with national operations. So no one basin or one fuel can you know, cause any catastrophic change in their business, can cause any catastrophic change in their business. So the quality of the companies has not just risen because of their lower leverage and better coverage of dividends, but also diversification in size. So, like Energy Transfer because last time I looked was about a $40 billion company, a strong BBB investment grade credit and it used to be, you know, six years ago was probably a double b credit, was probably a third the size, and they just bought so many assets and created this national north american really energy infrastructure HACCP portfolio. That's pretty resilient in most markets so it's more appropriate for retirement type income because the quality of the companies and size of the companies have risen.

Speaker 1:

You've mentioned the active management component of AMS. How do you go about determining weighting is what makes something rise to the top right well, we.

Speaker 2:

There's two ways to add value in amso. We do stock picking, as you're indicating. We also write covered calls, so and we do that on a stock by stock basis. So if a stock, our models show that it's overvalued, we'll write it at level, but we do have models on each company. And then we look at relative PEs compared to growth plus yield.

Speaker 2:

It's very important for MLPs to do like a lot of people heard, peg, which is PE to growth, and that's fine if you're a tech investor and there's no dividends, but you should never ignore the dividends as part of your return. So it's really P ratio to growth plus yield, and so we look at which companies are the highest quality so we'll give a premium for being the highest quality and then how they stack up on their P to growth plus yield ratio. And it's strange I never heard anybody else mention that. But you absolutely have to mention that. But you absolutely have to do that, otherwise you always buy tech stocks and never buy utilities, for instance, or you'll buy utilities with no dividends all the time, when the ones with dividends are probably better companies. Because with utilities, you know, the growth rate is driven by the retained earnings. So the lower the dividend, the more you grow. So it's that's I kind of know that math because of any utility investment payer, because they're inspired by regulation, not, you know, because the rate of return is regulated.

Speaker 2:

A lot of times people look at their yield stocks, say, oh well, this is underperforming the S&P, but they don't look at well, they're not looking at total return. They're, but they don't look at the well, they're not looking at total return, they're looking at yield. Now we don't believe in saying, oh well, you have a loss in this, but with the income you'd have a gain, because we want the income to be like have a growing stock price and income and you can only get that with really good coverage. So we always require all of our companies and all of our funds, like ICAP, S-CAP or dividend funds too, to have really good coverage. So you don't get that situation where people look at their account and say, oh well, I know I'm getting really good yield on this, but I have a big loss. We don't want that. We want capital appreciation plus yield.

Speaker 1:

It's funny to me how we entered a world where mental accounting, which is differentiating between yield and capital appreciation, is actually encouraged from a marketing perspective Right, as opposed to total return, which is really the only ultimate way to see performance. Let's talk about policy shifts.

Speaker 2:

How does anything under the Trump administration benefit or hurt the space? And a lot of its advisors had close ties to Bernie Sanders. They would have just shut down the hydrocarbon sector, but they don't have the power to do that. They can control drilling on federal lands and offshore drilling. So it's a much more long-term impact because you don't you know onshore Permian, you might drill a well and it'd be producing, and you know, at full production, like in a year. Offshore you're like five, six, 10 years. Even you have to build platforms, so it's more like a long-term growth prospect.

Speaker 2:

And then, the dumbest thing though, which probably never happened again, regardless of what party's in power is, the Biden administration was so extreme. They're trying to ban natural gas exports, which I'm an environmentalist, I've been working on renewables for 35 years and that's just a terrible thing for the environment. It's a good example where you don't extremism doesn't work on both sides of the political aisle, because natural gas is the cleanest fuel in the world Four hydrogen atoms, one carbon atom, and so it's the most efficient way to transport hydrogen, because it's nearly impossible to transport hydrogen without that extra carbon atom. It stabilizes it and allows you to turn it to a liquid at much higher temperatures and so it's way more efficient to transport hydrogen as natural gas than it is on its own. So this purism was causing the environment to be way worse.

Speaker 2:

And, president, the Trump administration has taken off those restrictions on LNG exports, is encouraging them and actually marketing them overseas, and that's part of this tariff negotiation. I'm sure a lot of countries will agree to take our LNG, because Trump administration is very focused on trade surpluses and deficits, which is probably not the greatest policy, but that's what they're focused on. So it's an easy thing for a country to do. Like they're buying LNG from Saudi Arabia, let's just buy it from us. It's the same price, so it's a global price. So that doesn't see easy giveaway to the Trump administration.

Speaker 1:

Yeah, it's definitely an interesting point on that end of the Trump administration. Yeah, it's definitely an interesting point on that end, speaking about future demands for energy and you know sort of where the world's going. Is there a link that one can draw between AI demand and MLP growth in general and pipeline growth On the?

Speaker 2:

natural gas side for sure, because you just have to have natural gas generation, and I was going to mention my son's on a exchange program in spain and their whole country including portugal, because it's on that peninsula, I guess went down for like 12 hours, which didn't sound like that long a time, but in modern economy that's just an unmitigated disaster. Nobody can do anything. Food spoils, hospitals have issues, and so the problem is that they at times were using 100% renewables to generate power. We don't know exactly what the power problem was. They claimed it was atmospheric issues, which I don't really know what that means. I guess sunspots, I'm not sure, but I think it's just. Probably maybe the wind wasn't blowing, and you kind of don't want to hear that like, oh okay, we're having a blackout because the wind's not blowing. So you, just like I said, I'm all in favor of renewables, but you have to have enough natural gas to create stability in the grid, and so in particularly in the US, where we're a bigger country, you have to have these big both it's called baseload plants and peaking when there's a shortage of wind or sun I guess more likely in Europe and stabilize the grid. So you can't do without it. It's totally impractical to think you can, and that's why it's a relief to have you know the Biden administration behind this Because, like I said, any reasonable Democrat would know that it's not like very controversial.

Speaker 2:

It's a very clean fuel and it displaces coal. That's why our carbon emissions have dropped the most in the world. They're down about 20 percent over the last 20 years, and it's just. You know, my theory, one of my theories of environmentalism is the best. Environmentalist is an economist. If you have have an efficient economy, you're going to produce less, less emissions, less pollution. Now, in an ideal economy, you would tax the pollutants that you know did hurt the environment and hurt the citizens, which we don't do because taxes aren unpopular. So if you're really going to have a free, that's what economists would tell you to do is tax carbon tax, so that tax stocks, not. So that's really the way to do it. But letting the economy operate is critical. If you don't, you end up with the charging stations that increase carbon because nobody uses them but you had to build them. A lot of uneconomic decisions which actually, even though they sound wonderful, actually produce more carbon.

Speaker 1:

Jay, for those who want to learn more about AMSA and the different ETFs that you have to offer. Obviously, where would you point them to?

Speaker 2:

wwwinfracapfundscom and all six of our funds are available there Three fixed income and three equity income.

Speaker 1:

And if those that are watching slash listening are on Substack, also, check out infrastructurecapitalsubstackcom. A lot of interesting commentaries that I've seen there as well, jay, appreciate you, I think very educational and hopefully I'll see all those that are watching this live on the next episode of Lead Black Live. Thank you, jay.

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Michael A. Gayed, CFA

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