Data as of March 31, 2018 unless otherwise noted.

PERFORMANCE (TOTAL RETURNS)
BENCHMARKS MARCH 2018 YTD
Alerian MLP Index (AMZX) -6.94% -11.12%
Alerian Energy Infrastructure Index (AMEIX) -3.40% -13.21%
ICE BofAML U.S. High Yield Energy Index (HY Energy) -0.86% -0.96%
S&P 500 Energy Index (S&P Energy) 1.66% -5.88%
Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.

FERC adds to midstream woes: The rally in MLPs and energy infrastructure in January now feels like a distant memory. March started out positive, with both midstream indices rising over 1% for the first half of the month. However, the Federal Energy Regulatory Commission (FERC) ruling on March 15, which will likely eliminate an income tax allowance for certain MLP-owned interstate pipelines, sent both MLP and non-MLP infrastructure companies lower. While many market participants expect the impact from FERC to be limited to only a handful of MLPs, this additional piece of negative news reinforced the negative sentiment already surrounding the sector. Against what would typically be viewed as a favorable fundamental backdrop, steady commodity prices and increasing production, MLPs and other energy infrastructure companies continue to move lower. HY Energy also fell for the month, but its decline was generally in line with broader weakness in the high yield bond market. S&P Energy, given its large exposure to upstream companies, rose alongside higher oil prices, which finished the month up 5.4%.

Midstream valuations look attractive: As midstream earnings prospects remain generally favorable and stock prices continue to move lower, valuation metrics for midstream companies look increasingly attractive. According to Wells Fargo, its midstream MLP universe is currently trading at a 24% discount based on yield and an 18% discount based on enterprise value to EBITDA (EV to EBITDA) compared to 10-year averages.1 Similar discounts are also observed for non-MLP midstream companies. The EV to EBITDA ratio, which serves as a proxy for price to earnings, is at its lowest level since Q3 2009 and in the bottom 10% of all results since 2005.1 If this ratio recovered so that the EV to EBITDA ratio traded at a level representing only one-third of its max value since 2005, that would imply a 25% price increase for investors. While negative investor sentiment continues to weigh on the midstream sector, metrics based on yield, valuation and earnings appear more and more compelling.

KEY TAKEAWAY

While business fundamentals for the energy sector remain generally supportive, investor sentiment, especially for MLP and midstream equities, remains particularly negative. This has resulted in what we believe are historically cheap valuations for energy infrastructure.


1 Wells Fargo, “Weekender: FERC Fallout,” March 23, 2018.


Index descriptions: Alerian MLP Index is the leading gauge of energy Master Limited Partnerships (MLPs) and is a float-adjusted, capitalization-weighted index, whose constituents represent approximately 85% of total float-adjusted market capitalization. Alerian Energy Infrastructure Index is a composite of North American energy infrastructure companies and is a capped, float-adjusted, capitalization-weighted index, whose constituents are engaged in midstream activities involving energy commodities. ICE BofAML U.S. High Yield Energy Index is designed to track the performance of U.S. dollar-denominated high yield rated corporate debt publicly issued in the U.S. domestic energy market. S&P 500 Energy Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS) energy sector.


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This energy market commentary and any accompanying data is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The energy market commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such energy market commentary. The energy market commentary should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the energy market commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.