The energy sector offers investors some of the best opportunities to generate income. Many companies boast dividend yields significantly above the S&P 500‘s 1.7% average.
Two standouts are Energy Transfer (NYSE: ET) and Crestwood Equity Partners (NYSE: CEQP). The master limited partnerships (MLPs) offer monster yields and are about to hit a critical inflection point. That makes them great options for income-seeking investors to buy this year and hold for the long haul.
Getting back up to the peak
Energy Transfer’s distribution currently yields 8.4%. That big-time payout is on an increasingly sustainable foundation. The MLP grew its earnings and distributable cash flow by 20% in the third quarter, fueled by improving market conditions, expansion projects, and the acquisitions of Enable Midstream and Woodford Express. The pipeline company produced enough cash to cover its massive distribution by 1.93 times in the period, enabling it to generate $760 million in excess cash flow. That gave it the money to cover capital expenditures and strengthen its balance sheet.
The MLP’s steadily improving balance sheet over the past year has allowed it to boost its distribution. It has grown the payout by 70%, pushing the per-unit rate to $0.265 each quarter. Energy Transfer wants to get its distribution back to its former peak of $0.305 per unit (15.1% above the current level). It should be able to deliver on that goal as it achieves its targeted leverage ratio of 4 to 4.5 times debt to earnings before interest, taxes, depreciation, and amortization (EBITDA), which it was on track to hit by the end of last year.
That would free up more cash flow to invest in additional expansion projects, make acquisitions, and repurchase its units. The company planned to spend up to $2 billion on expansion projects last year, which will grow its distributable cash flow. Meanwhile, it has several more in the pipeline, including a potential liquified natural gas export facility it’s close to approving. As its expansions grow its cash flow, Energy Transfer would have more fuel to expand its distribution past the former peak.
Repositioned and ready to cash in
Crestwood Equity Partners currently offers a 9.8% distribution yield. Last year, the company took several steps to enhance the foundation under that massive payout.
The MLP completed several deals, including closing its acquisitions of Oasis Midstream Partners, Sendero Midstream, and its partner’s interest in a joint venture. It also sold two non-core assets. These moves enhanced its position in its three core regions without straining its balance sheet.
The company expects those deals to pay dividends in 2023 as it completes its integration and the associated expansion projects. It expects to generate significant and growing free cash flow.
Crestwood initially plans to allocate excess cash toward reducing leverage. It aims to get its debt-to-EBITDA ratio down from around 4 times to its long-term target of 3.5 times this year. That would give it the additional financial flexibility to return more cash to investors through a higher distribution and by repurchasing common and preferred units.
By strengthening its already solid financial position, Crestwood would also be in a better place to continue its consolidation strategy. The company has been steadily acquiring other gathering and processing companies in the Delaware, Williston, and Powder River basins, enhancing its scale in those three regions. Future deals would help grow its cash flow, allowing Crestwood to continue increasing its distribution (it gave investors a 5% raise last year after closing the Oasis Midstream deal).
Big-time income streams
Energy Transfer and Crestwood Equity Partners enhanced their portfolios and financial profiles last year. That put them both in a better position to sustain and grow their already massive distributions. That combination of income and upside potential makes them look like great long-term buys for yield-seeking investors this year.
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Matthew DiLallo has positions in Crestwood Equity Partners and Energy Transfer and has the following options: short February 2023 $11 puts on Energy Transfer. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.