Energy prices have been volatile recently due to geopolitical issues. And, in fact, oil prices have moved in ways that some onlookers hadn’t been expecting, highlighting the inherent risks of investing in the energy sector. Unless, that is, you sidestep the commodity risk by focusing on the midstream. And there’s one high-yield midstream option that stands out today.
Why invest in the midstream?
Upstream energy businesses extract crude oil and natural gas. As such, their top and bottom lines are almost entirely dependent on commodity prices. Downstream businesses use oil and natural gas to produce chemicals and refined products such as gasoline. So not only do they rely on volatile-priced commodity inputs for their processes, but the products that they produce are largely commodities themselves.
Image source: Getty Images.
Midstream energy businesses are different. They own energy infrastructure, like pipelines and storage facilities, that connects the upstream players to the downstream and on to the rest of the world. Midstream companies generally charge fees for the use of their assets, a business model that tends to generate consistent cash flows regardless of the prices of the commodities flowing through their systems. They use large fractions of those cash flows to pay dividends, which tend to be fairly generous in the midstream sector.
But not all midstream businesses are created equal. For example, at their current stock prices, Energy Transfer (ET 0.06%) is offering a 7.2% distribution yield while Enterprise Products Partners‘ (EPD -0.45%) yield is 6.9%. Yet if you are a dividend investor trying to build a reliable income stream for the long term, you’ll be better off going with Enterprise’s lower yield, whether you have $1,000 or $10,000 to invest.
Enterprise is reliable and boring
Why not pick the stock with the highest yield? The answer is simple: Because consistency is more important to most long-term dividend investors than yield. That’s especially true in a case like this one, where the difference between the two yields is only 30 basis points. The chart below clearly illustrates this.
Data by YCharts.
Though the two have similar businesses, they don’t always behave in the same way. Energy Transfer cut its dividend in 2020 amid the energy downturn caused by the start of the coronavirus pandemic. Sure, it returned to growing its payouts again fairly quickly, but those payments shrank dramatically right when most income seekers would have wanted reliability. By contrast, Enterprise Products Partners increased its distribution in 2020. Its streak of annual increases is now up to 26 consecutive years.
Boring and reliable distribution growth is a key reason why investors should be considering Enterprise Products Partners today. The high yield should be appealing, too. But there’s another little wrinkle: The dividend isn’t the only reliable and boring part of the business. The master limited partnership has a solid financial foundation (its balance sheet is investment-grade rated), and management sets realistic goals that it tends to hit year in and year out.
To use Energy Transfer as an example again, that business set plans in motion to buy another company in late 2015. An energy downturn in 2016, however, led Energy Transfer to get cold feet. It eventually scuttled the deal, but not without an ugly black eye from the legal battle that ensued. Or, consider Kinder Morgan (KMI 0.18%), another North American midstream giant. Its management team told investors to expect large dividend hikes in 2016 and 2020. Instead, in response to shifting macroeconomic conditions, it cut its payout in 2016 and provided a hike that fell well short of its original dividend goal in 2020.
Enterprise muddled through both of those tough periods for the energy sector in relative stride without making promises it couldn’t keep or cutting its distributions.
Enterprise Products Partners is the one to choose
Some investors might find reasons to justify buying Energy Transfer or Kinder Morgan over Enterprise Products Partners. But if you are putting $1,000 or more on the line, boring and reliable Enterprise provides a history of income and reliability that many of its peers just can’t match. Erring on the side of safety is the right call in the energy sector, particularly if you’re using the income your portfolio generates to help cover your living expenses.
Focusing on the midstream segment is a good first step. But homing in on an industry leader like Enterprise is even better. At the current stock price, a $1,000 investment would net you around 31 units of this reliable high-yield MLP.
Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Kinder Morgan. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.