If you are looking for big dividend yields, then a good place to start your search is the midstream segment of the energy sector. But don't blindly buy the highest yielders -- they can come with more risk than you expect. That's why you should probably avoid Energy Transfer(NYSE: ET), which yields 8.1% at its current share price. But the 7% yield from Enterprise Products Partners(NYSE: EPD) and the 7.8% yield from Enbridge(NYSE: ENB) are both rock solid.
Energy Transfer let investors down, again
Energy Transfer cut its dividend in half in 2020 during the deep energy-sector downturn that was caused by the coronavirus pandemic. That alone is good enough reason for investors to look upon the midstream giant's big 8.1% yield with a little trepidation. But if you go back to 2016 or so, when Energy Transfer was trying to buy Williams Companies(NYSE: WMB), you'll find an even bigger reason to worry.
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To summarize a complex issue, Energy Transfer got cold feet and attempted to call off the Williams deal. Williams refused, and there was a contentious fight. Energy Transfer warned that consummating the transaction would require taking on huge amounts of debt, a distribution cut, or both. During that battle, Energy Transfer sold convertible securities, a large percentage of which went to the CEO. Those conversions would have effectively protected the CEO from the financial impact of a distribution cut.
So not only did Energy Transfer cut its distribution in the face of industry hardship in 2020, but it previously made choices that could leave conservative investors with some trust issues with regard to its management. Yes, this master limited partnership (MLP) has a high yield. Yes, management is growing the distribution again. But most investors will likely be better off picking a different midstream option for their portfolios.
Enterprise and Enbridge reward shareholders even in hard times
In contrast to the actions of Energy Transfer, consider that Enterprise Products Partners has increased its dividend for 25 consecutive years. Enbridge, meanwhile, has hiked its payout annually for 29 years in a row. In other words, both continued delivering growing income streams to investors right through both the Great Recession and the pandemic. This history suggests you can count on these two North American midstream giants.
The core of each business is energy infrastructure, including pipeline, transportation, storage, and processing assets. These are largely fee-based businesses that generate reliable cash flows. Enterprise's distributable cash flow covered its distribution by a strong 1.7 times in 2023. Enbridge's distributable cash flow payout ratio of 65%, meanwhile, is smack dab in the middle of its 60% to 70% target range. Both have investment-grade rated balance sheets as well, so they are operating with strong financial foundations.
But which one is better? That may depend on your approach to diversification. Enterprise Products Partners is focused on moving oil and natural gas, and the products into which they get turned, around the world. Enbridge does those things too, but it also owns a natural gas utility business and is investing in clean energy assets. If you want a pure-play oil and natural gas stock, the better option is Enterprise. If you want an energy stock that's trying to shift its business in sync with the world that's shifting around it (toward cleaner energy alternatives), then you'll probably prefer Enbridge.
You don't have to sacrifice quality for a high yield
What's most interesting about the comparison between these companies is that they all have ultra-high yields. But Enterprise and Enbridge have proven to be more reliable stewards of investor capital. Sure, their yields are slightly lower, but in the long run, income investors will probably be much happier with a little less income and a lot more security.
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Reuben Gregg Brewer has positions in Enbridge. The Motley Fool has positions in and recommends Enbridge. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
