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Energy transfer (NYSE:ET) offers investors an ultra-high distribution yield of 8%. Partners for business products (NYSE:EPD) has a return of 7.2%. While both come from the midstream energy sector, they are not interchangeable investments. This is why a lower yielding company is worth buying hand over fist and most will probably be better off avoiding Energy Transfer.
The problem with energy transfer
When energy prices plummeted early in the coronavirus pandemic, Energy Transfer cut distribution by 50%. That 2020 distribution cut may have been justified by the uncertainty the world was facing at the time, but it was certainly not the distribution outcome investors were hoping for. And while the master limited partnership‘s (MLP) distribution starts to rise again and is actually higher than before the cut, investors concerned about income consistency should not ignore the choice management made in 2020. This carries the very real risk that the next downturn in the energy sector will lead to the same outcome.
Nevertheless, cuts in distribution are understandable in light of the setbacks in the energy sector. What is more difficult to explain at Energy Transfer is the failed purchase agreement from 2016 Williams Companies. Energy Transfer initiated the deal, but an energy crisis left the MLP with cold feet. Energy Transfer then tried to derail the deal, claiming that completing it would require taking on too much debt, cutting the dividend, or both. The attempt to get out of the deal included issuing convertible securities, and that’s where the real problem comes in.
The CEO at the time purchased a large portion of the convertible securities. The assurance would have effectively shielded the CEO from the impact of a dividend cut if the deal went through as planned, while shareholders would feel the full brunt of a cut. It was a complicated matterbut that is a disturbing view at the highest level. That CEO, Kelcy Warren, is now “just” the chairman of the board, so there’s still good reason to worry about what happened almost a decade ago.
Overall, Energy Transfer is probably not the place to look if you’re looking for a reliable income stream.
Enterprise Products Partners continues to put unitholders first
Enterprise Products Partners is another major North American midstream MLP. But it doesn’t have the same distribution negatives attached to it. For starters, it has increased its distribution annually for 26 consecutive years. Second, the company has been able to make regular acquisitions without resorting to aggressive tactics in an attempt to exit a transaction before it is completed.
But what’s interesting here is that Enterprise is not immune to the effects of an energy crisis. Although the business is largely fee-based, 2016 was a relatively difficult year, and so was 2020. The business continued to operate despite temporary weakness, and the benefit was increased despite that weakness. A key factor here is the conservative nature of Enterprise’s management, with the distribution supported by an investment grade balance sheet and a strong distribution coverage ratio (currently distributable cash flow covers the distribution 1.7 times).
There is also a long history of unitholder-friendly decisions to consider. For example, in 2002, Enterprise cut its incentive distribution rights by 50%, freeing up more money to pay shareholders at the expense of the general partner. In 2007, management slowed distribution growth so it could invest more heavily in business expansion to increase long-term returns. In 2011, the MLP eliminated incentive payments and purchased its general partner, effectively becoming a self-governing entity. And in 2018, Enterprise tried to become a self-financing company so it wouldn’t have to issue as many dilutive units in the future.
Stick with the one you can trust
It’s not an exciting investment, but Enterprise has clearly looked out for shareholders in a way that Energy Transfer hasn’t. If you are trying to live off the income your portfolio generates, a reliable company, despite a slightly lower return, is probably the better option than Energy Transfer in the long term.
Do you now have to invest € 1,000 in energy transfer?
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Ruben Gregg Brouwer has no position in any of the stocks mentioned. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has one disclosure policy.
1 ultra-high return energy stock to buy by hand and 1 to avoid was originally published by The Motley Fool