NXG CEF: Distribution Consolidation Does Its Job (NYSE:NXG)

Written by Nick Ackerman, and co-produced by Stanford Chemist.

Timing of my latest update on the NXG NextGen Infrastructure Income Fund (New York Stock Exchange: NXJ) She turns out to be incredibly poor. The “buy” rating ultimately turned out to be a good call, but that’s where it ended The buying opportunity became much better after about a month or so. The broader market entered correction territory, but for a fund invested in several companies focused on renewable energy, that led to a further decline.

Today, the discount has narrowed but the distribution remains incredibly attractive – something that could continue to bring interest to the fund as it can move into a premium. However, I would be more patient with wanting to invest in this fund, given the current tight discount. One could even consider making some profits with this name if they have those profits waiting for them A more suitable time to invest.

NXG Basics

• One-year Z-score: 1.30
• Discount: -5.83%
• Distribution yield: 15.49%
• Expense ratio: 1.94%
• Leverage: 29.06%
• Assets under management: $152 million
• Structure: durable

NXG will seek to “invest in a portfolio of stocks and debt securities of infrastructure companies, including energy infrastructure companies, industrial infrastructure companies, sustainable infrastructure companies, and technology and communications companies.”

This provides a very flexible portfolio that includes everything related to infrastructure, whether digital infrastructure, renewables or legacy pipes.

The fund’s largest weighting is currently allocated to large-cap and diversified companies.

The opponent narrows financially

At this point, the total share price return since the previous update is 22.3%, but the timing hasn’t been great. Not only did the entire market hit correction territory in October 2023, a month or so after my last update, but renewables took a big hit during that period as well.

That was thanks to NextEra Energy (NEE) announcing that its subsidiary, NextEra Energy Partners (NEP), expects about half the growth in its distribution and is cutting its earnings forecast. This was only two months after repeated predictions that things were on the right track. This sent NEP arrows south, but took with it other, renewed names.

At the time, NXG’s largest position was NEP, followed by Atlantica Sustainable Infrastructure plc (AY) and the fifth-largest name, Clearway Energy (CWEN).

CWEN has worked its way to the top during this time, with AY not far behind. On a side note, AY is looking to be bought, but the advertised offer was actually lower than the stock’s trading price. This led to shares falling after this announcement recently.

The NEP is still down meaningfully from this initial decline, but has been trending higher.

The main risk for NEP remains that NEE’s parent company may make an acquisition. The only reason the NEP exists is to benefit the NEE primarily through spin-off deals and financing new renewable growth projects. If it did not become a source of growth and currency for NEE, it would not need to exist.

Obviously the management team is giving it some time before giving up, but that’s the general idea. NEE could suspend NEP distributions entirely, see the unit price completely collapse, and then return them to their business for a fraction of the current unit price. Hence the risks of “capture” that the new economic policy carries.

For what it’s worth, NXG no longer holds any of these three spots in the top ten. Instead, they keep traditional pipeline teams and MLP teams in the top 10.

For NXG, more specifically during this time, the actual fundamental performance has not been very strong. At least on a relative basis. The stock’s big rise came primarily from discount contraction.

For some context on performance in this time frame, we’ve also included several other securities for some sort of measure. This includes the Energy Select Sector SPDR ETF (XLE), the Utility Select Sector SPDR ETF (XLU) and the Global X MLP & Infrastructure ETF (MLPX). For good measure, I’ve also thrown in the SPDR S&P 500 ETF (SPY).

The fund’s discount is much narrower than its long-term average at the moment. However, it may be interesting to note that prior to the Covid collapse and the fund’s eventual change to a more hybrid renewable infrastructure fund, this type of deduction was not completely out of the ordinary. It’s the time frame from Covid to now that has actually driven down the average fund discount.

Distribution narrows the discount

The obvious catalyst for narrowing the fund’s discount in this time frame was the doubling of the fund’s distribution. It happened right when we initially covered the box. The fund went from covering its distribution with distributable cash flow to covering it at about 50%.

Lucky for us, NXG provides us with a DCF number (although it’s a fairly easy calculation if we had to do it on our own because it’s simply NII plus ROC distributions added back in.) NXG provides a breakdown of Distributable Cash Flow Coverage, or DCF. , on two different scales, without and with fund expenses. As we can see, DCF, taking expenses into account, provides coverage at 1x. Since the fund is an equity fund, seeing DCF coverage of 1x or more is all we’re really looking for. This coverage has also increased since the end of the last fiscal year.

With the release of the fund’s latest annual report, we can see that coverage has already begun to decline.

However, the higher distribution was not actually present until the monthly distribution in September 2023. Therefore, we should see the coverage numbers weaken further.

However, the idea was to narrow the fund’s discount with such a move, and it certainly happened. He took it from a relatively stable infrastructure fund with a renewable hybrid orientation that traded at a significant discount to more of an ETF. There is absolutely nothing wrong with that; It takes more monitoring.

As we saw with its sister fund, NXG Cushing Midstream Energy Fund (SRV), which put this strategy into action earlier, they conducted a rights offering as soon as the fund touched the premium. With the N-2 filing for NXG, this could be the next step for this fund if it reaches premium. The fund conducted rights offerings in 2018 and 2019, so there’s history there as well.

It should be noted that thanks to the strong energy market, SRV has seen no fund wear at all at this time. With an NAV ratio of approximately 13% plus fund expenses, one would expect to see little erosion as this is a fairly high rate to achieve over the long term. This also includes the fund’s diluted rights offering which has seen a slight hit to NAV as well.

For what it’s worth, NXG has also seen its NAV perform incredibly well through 2024, bringing it back to where it was when it initially announced the higher distribution. NXG’s NAV ratio is higher, though, at 14.59%, which may make it more difficult to maintain NAV.

Conclusion

NXG has seen its discount narrow materially, which is to be expected when the fund doubles its distribution. While investors can push the fund to a premium, as we’ve seen with SRV, I think it’s time to take some profits off the table. At the very least, I would be more reluctant to increase my position into this name at current levels.