There's nothing inherently wrong with oil and gas drilling company Helmerich & Payne, Inc. (NYSE:HP). The real problem is that it's in a highly cyclical industry, which means you need a strong stomach to ride the often-wild earnings swings. However, if what's attracted you to the company is its hefty 6.4% dividend yield and a long history of annual dividend increases, you have other options in the energy space. Consider looking at Enterprise Products Partners L.P. (NYSE:EPD), Magellan Midstream Partners, L.P. (NYSE:MMP), and Holly Energy Partners, L.P. (NYSE:HEP).
Similar but different
Helmerich & Payne builds drill rigs, rents them out, and runs them for oil companies. It focuses on the U.S. onshore market, where it derived about 80% of its revenues in the fiscal second quarter. To give you an idea of just how volatile this business can be, a year ago only 24% of the company's U.S. rigs were working. Today that number is up to 54%.
Although the company is used to this and focuses on protecting its cash flow so it can support its dividend and 44 consecutive years of annual dividend growth, there's a lot of variability in its top- and bottom-line results. A big determinant of rig demand is energy prices: when oil prices are high, more drilling tends to take place; when prices are low less drilling takes place.
Enterprise, Magellan, and Holly also provide services to the energy industry, but their businesses are largely fee-based. They are midstream oil and gas partnerships, helping to move oil and gas from where they are drilled to where they eventually get used. In this case, demand for oil and gas is more important than price. As such, this trio's results tend to be a lot more consistent. And each has plenty to offer income investors.
1. The big play
Enterprise is one of the largest midstream partnerships. It has a 20-year history of annual dividend increases, including increases in each of the last 52 quarters; its distribution yield is currently around 6.6%. It's probably the best option for risk-averse types because it provides broad diversification and is conservatively run. Long-term debt, for example, is about 45% of the capital structure, a reasonable number for a capital-intensive industry with steady recurring fees.
The company used the energy downturn to opportunistically acquire three midstream businesses. Even with that spending and continued investment in its own assets, its coverage ratio never dipped below 1.2. It currently has about $9 billion in capital spending on tap to support continued distribution growth. Distributions have historically increased about 5% each year.
2. Smaller, but faster growing
Magellan is a much smaller partnership, and its yield is roughly 5.4%, lower than those of both Enterprise and Helmerich & Payne. It's increased its annual distribution each year for 17 years, including in each of the last 30 quarters.
Don't pass Magellan by just because those numbers seem low. What sets this partnership apart is that its distribution has grown at around 11% annually over the past decade -- more than three times the historical growth rate of inflation and around twice as fast Enterprise's distribution.
Here's the thing: the partnership appears to be gearing up for more growth. It's set up an at-the-market equity program that will allow it to easily sell new units to fund its growth plans. Right now it has around $1 billion of projects underway, but it's evaluating another $500 million worth for the near future. Look for Magellan's distribution to keep moving higher from here.
3. The high yielder
Holly Energy Partners is a little riskier. Although 100% of its revenue is fee-based, with around 80% linked to long-term contracts, its debt levels are higher than those of many peers. For example, long-term debt makes up roughly 75% of the partnership's capital structure. That helps explain the over-8% distribution yield.
However, Holly has a 13-year history of annual hikes, with increases in each of the last 51 quarters. Distribution growth has averaged around 6% annually over the past decade.
Here's the thing: Holly's debt has been used to buy assets, like the recently announced purchase of the remaining interests in two pipelines for $250 million (it already owned portions of each). These acquisitions help to push the top- and bottom-line higher and support continued distribution growth. Management, meanwhile, is comfortable pushing debt higher in the short-term to support long-term growth. There's definitely more risk here, but the high yield might be worth it to you.
No free lunch
Clearly, there's no way to completely avoid risk when you invest. However, you can avoid sectors that are prone to volatility, like drilling services. Sure, Helmerich & Payne's dividend is enticing, but you can find equally exciting yields in the midstream space, where consistent fees and steady growth are the norm. In that sector giant Enterprise is a great option for conservative investors, lower yielding Magellan is good for those seeking faster distribution growth, and Holly's high yield could be right if you don't mind a little more risk. None of this trio, however, should see the types of business swings that have rocked Helmerich & Payne over the past few years.