High Yield Income Portfolio - Oct 18

[dan_s]

My focus for our High Yield Income Portfolio is to find companies with solid operating cash flow that can sustain and eventually increase their quarterly dividends. The portfolio is split between C-Corps. and MLPs that offer annual yields of 5% to over 10%. As of 9-30-2021 the average annual yield was 8.4%. In addition to high yield, I think the portfolio has 10% to 20% share price upside because generalist investors are just beginning to rotate money into the energy sector. Large-cap midstream companies "feel" safer to investors and fund managers that don't have a good understanding of the upstream sub-sector.

Morgan Stanley 10-18-2021

MLPs & Midstream Energy Infrastructure | North America
Midstream Weekly
Midstream continues its upward move, with commodity inflation starting to drive increased investor interest in the broader energy sector.

Midstream trades higher for the fifth consecutive week – notably, the first of
the five in which the sector outpaced broader energy – and is now approaching
June YTD highs. As we are returning to more in-person meetings and have been
on the road sitting down with investors across the country, we have seen
tangible renewed interest in energy in recent weeks. Generalist inbound interest
in energy has skewed long/short but also included new long only dialogue,
focused on the prospect of a sustained commodity price inflation cycle,
significant up coming return of capital, and the potential for higher stock
performance and index weightings to drive new energy buying to ensure
benchmark replication. Interest has tended to focus primarily on upstream, as
E&Ps – in relation to midstream – offer more direct torque to higher commodity
prices in a capital disciplined environment, higher FCF yields (median E&P yield
approaching 20%, roughly double that of midstream),and comparatively more
developed return of capital frameworks.

Despite the greater relative preference for upstream, we still see compelling
arguments for continued strength in midstream performance. Although
sustained and significant fund inflows offer a more optimal backdrop, the setup
for midstream is nonetheless constructive, in our view. We believe narrowed
institutional participation leaves trades less crowded and gives rise to mispricings
(reminiscent of K-1 related institutional aversion to MLPs in the 2000s, although
today done more for discretionary than back office reasons), strength in
underlying midstream fundamentals creates durability to cash flows that
underpins valuations, and incremental return of capital (share buybacks,
deleveraging) offers catalysts to help close disconnects that exist. To the extent
sector fund outflows have largely stabilized, the prospect of sustained
midstream performance in the coming years exists without requiring multiple
expansion or EBITDA growth, with capital structure reduction offering more
likely and immediate value recognition than ongoing capital reinvestment. To be
clear, the argument is less about solving for return of capital over reinvestment
to an extreme (a potential zero sum game if new investor interest is offset by the
alienation of others), but in finding a balanced approach that recognizes that
capital structure reduction is likely to help catalyze new investor interest and
differentiate relative performance.