Over the past year, I have devoted a great deal of time and effort to analyzing master limited partnerships, particularly ones in the energy industry, and the opportunities that they present to investors. These entities are things that are very appealing to many investors due to their strong growth prospects and the high distribution yields that they tend to pay out. There are, of course, other ways to take advantage of the opportunities presented by the second than buying individual firms. One way is by buying funds that invest in the sector as these provide an easy way to gain exposure to a diversified portfolio of master limited partnerships. One interesting such fund is the First Trust New Opportunities MLP & Energy Fund (FPL), which will be the topic of the remainder of this article.
About The Fund
According to the fund’s web page, the First Trust New Opportunities MLP & Energy Fund has the objective of seeking a high level of total return with an emphasis on current distributions paid to the fund’s shareholders. The fund seeks to accomplish this by investing in cash-generating securities, particularly master limited partnerships and similar companies in the energy sector as well as energy utilities. In this regard, the fund is quite similar to the First Trust Energy Income & Growth Fund (FEN). The difference between the two funds is that FEN only invests in master limited partnerships while FPL also includes utilities in its portfolio. We can see this quite clearly by looking at the ten largest holdings of FPL. Here they are:
Source: First Trust
As we can see here, the majority of the companies in the fund’s top ten holdings are master limited partnerships, mostly midstream or pipeline ones. However, we also have firms such as TransCanada (OTCPK:TNCAF) and Kinder Morgan (KMI) that are not partnerships but have very similar business models to them. This business model includes the generation of revenues through non-cyclical fee-for-service contracts that insulate the company against commodity price fluctuations. This is something that many conservative investors like about midstream and pipeline companies. We also see here that the fund is investing is Exelon Corp. (EXC), which is an electric utility. This is something else that the fund does differently than FEN, as FEN does not generally invest in utilities (although it does still invest in electricity generation companies). Utilities do tend to be non-cyclical businesses as well; after all, people tend to prioritize paying their electric bills over most other expenses in lean economic times, so electric utilities tend to appeal to conservative investors.
As my regular readers on the topic of closed-end funds likely know, I generally dislike seeing any single position in a fund account for more than 5% of its total assets. This is because a 5% weighting is approximately the level at which an asset begins to expose the fund to idiosyncratic risk. Idiosyncratic, or company-specific, risk is the risk that any financial asset possesses that is independent of the market as a whole. This is the risk that we aim to eliminate through diversification, although clearly if a position accounts for too much of the portfolio then this risk will not be completely diversified away. Thus, the concern here is that if some event occurs that causes the stock price of a given heavily-weighted asset to decline independently of the market, then it will drag the entire fund down with it. As we can see above, there are seven positions that currently account for more than 5% of FPL’s total assets with one of them, Enterprise Products Partners (EPD), accounting for a whopping 13.11% of assets. Thus, the fund is fairly heavily concentrated in just a few stocks so shareholders or potential shareholders should be aware that they are heavily exposing themselves to the fortunes of these few companies.
Although the fund is highly exposed to only a few companies, it is fairly well diversified across the various sectors in which it invests. We can see this clearly here:
Source: First Trust
This industry breakdown is almost identical to that of FEN. That almost certainly comes as something of a surprise given that the latter fund focuses on master limited partnerships to a greater degree than FPL does. It is certainly nice to see that the fund has fairly balanced exposure to its focus industries, without having any one sector with outsized exposure. This should help protect the overall portfolio against problems in any individual sector, although as already mentioned these sectors are all relatively non-cyclical and in most cases have quite stable revenues. In the case of pipeline companies, they even have a certain amount of their revenues guaranteed by contracts. Thus, it is somewhat difficult to see what sort of problem could result in problems across one of these industries, but it is still nice to see that the fund is not putting all of its eggs into one basket here.
Why Invest In Midstream?
As we can see above, roughly 80% of the fund is invested in North American pipeline companies. These companies have been benefiting significantly from the growing oil and natural gas production in the United States and Canada in the couple years since the oil bear market in the middle of this decade ended. As we can see here, the production of both oil and natural gas is broadly higher today than it was a year ago in every major resource basin in the United States:
Of course, this production growth is essentially worthless unless the companies producing it have a way to get the newly produced resources to the market to sell them. This is where the pipeline companies come in as pipelines are generally the most cost-effective way to get these resources to market. As pipeline companies generate revenues based on the volume of resources flowing through their pipes, the fact that more resources are being produced and shipped can be expected to have a positive impact on the finances of these companies. This is indeed the case, and indeed, we have been seeing many of these firms deliver quite a respectable performance and growth in recent quarters.
Current projections point to continued production growth over the next few years. In fact, this production growth is expected to be quite rapid, as we can see here:
As we can clearly see, the Bakken shale region of North Dakota is expected to grow its production of crude oil by 55% between now and 2021 while the venerable Permian basin in West Texas is expected to boost its production by a remarkable 80% between now and 2021. This production growth will naturally result in growing demand for transportation away from these basins. The nation’s pipeline companies have already begun constructing new pipelines to meet this demand, which should drive fairly strong growth across the industry over the next few years.
The general reason why most investors purchase units in master limited partnerships is because of the high distribution yields that they typically possess. Utilities tend to have a similar thesis, although their yields are typically not as high. As such, we might expect FPL to boast a fairly high yield. This is indeed the case as the fund pays a monthly distribution of $0.075, which works out to $0.90 annually. This gives the fund a distribution yield of 9.69% at its current price of $9.29 per share.
One thing that might concern many investors is that a fairly sizable percentage of the fund’s distributions are classified as return of capital:
The reason why return of capital distributions can be concerning is that a return of capital distribution can be an indication that the fund is essentially returning an investor’s own money back to them. This event would be destructive to the fund’s total value and is obviously unsustainable over the long term. However, there are other things that can cause a distribution to be classified as a return of capital, one of which is the distribution of money received from partnerships. This is the case here. Thus, investors should not really worry about the fact that the fund’s distributions are classified as return of capital and instead simply enjoy the tax-advantaged income.
As is always the case, it is critical for us to ensure that we do not overpay for any asset in our portfolio. This is because overpaying for any asset is a surefire way to ensure that we will generate sub-optimal returns from that asset. In the case of a closed-end fund like FPL, the usual way to value it is by looking at a measure known as net asset value. Net asset value is the market value of all of the securities held by the fund minus any outstanding debt. It is therefore the amount that the investors in the fund would receive if all of the fund’s assets were sold off and it was liquidated.
Ideally, we want to buy a fund when it is trading for less than its net asset value. This is because this situation essentially means that we are acquiring all of the fund’s assets for less than they are actually worth. This is the case right now with FPL. As of May 16, 2019 (the latest date for which data was available as of the time of writing), FPL had a net asset value of $10.31 per share. As the fund currently trades hands for $9.29 per share, it is selling at a 9.89% discount to net asset value. This is certainly a reasonable price to pay for the fund.
In conclusion, the First Trust New Opportunities MLP & Energy Fund is an interesting way to play the current strength in the midstream energy sector. The fund is decently well diversified across the various types of pipeline as well as electric utilities, although it is fairly concentrated in only a few companies. The fund does offer investors a high level of tax-advantaged income, which may be expected from an MLP fund, and currently trades at a pretty hefty discount to net asset value so the price appears to be right. When we consider the expected forward growth in the industry, it would be reasonable to consider buying into the fund.
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Disclosure: I am/we are long FEN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.