There's no question that water heater maker A. O. Smith Corp (AOS +2.43%) has an amazing track record of success. That record is highlighted by 24 years of consecutive annual dividend hikes, with an annualized rate of increase of 16% over the past decade. And as it moves into India, it looks like it could repeat the success it had in China -- where sales have grown at 22% a year over the past decade. The only problem is the tiny 0.9% yield. For income investors looking for higher yields than that, here's why you should consider midstream industry stalwarts Magellan Midstream Partners, L.P. (MMP +0.00%) and ONEOK Inc. (OKE 2.00%) instead.
Conservative distribution growth
Magellan's yield is currently around 5.2%, more than five times what A. O. Smith offers, and more than double what you'd get from an S&P 500 index fund. The partnership's distribution track record doesn't stretch out to 24 years, but it has increased the payout every single quarter since coming public in 2001. The compound annual distribution growth rate over that span was an impressive 12%. That's not quite as fast as Smith, but that's the cost of looking for a higher yield.
If you're looking for income to help fund your retirement, A. O. Smith's low yield is a problem. Image source: Getty Images.
The best thing about Magellan is that it is a very conservatively run midstream partnership with a largely fee-based business, and so the price of oil and gas is less important than demand. Its debt to EBITDA is among the lowest in the midstream industry. Unlike many peers, it hasn't resorted to dilutive equity-unit sales to fund its growth, with the last major unit issuance occurring nearly eight years ago.
The future looks equally bright, with roughly $800 million in growth projects lined up for 2018. Most have customers in the wings or are at existing facilities where demand demonstrates a need for expansion. That should easily support the partnership's goal of 8% distribution growth. For 2019, it has $350 million of projects lined up, with the potential to add another $500 million to that total, suggesting another solid year of distribution growth.
Magellan's project pipeline is strong today. Image source: Magellan Midstream Partners, L.P.
With a robust yield, conservative management approach, and notable growth spending ahead, Magellan is a worthwhile option for income investors who like the A. O. Smith growth story but need more yield.
Change is in the air
ONEOK is another midstream player, but it isn't a partnership -- it's a regular corporation. The yield is a pleasing 5.7% (or so) and the dividend has been increased every year for 15 years. Like Magellan, its business is mostly fee-based, as well. The dividend has been increased at an annualized rate of around 16% over the past decade.
That said, ONEOK has a lot going on today. For example, it just bought its controlled limited partnership, simplifying its overall business structure. It's also working to trim its debt load, with the goal of bringing its debt to EBITDA ratio down below 4 times -- it's at 4.6 times today. Eve now, that's not an onerous level of debt, putting it roughly on par with midstream bellwether Enterprise Products Partners LP. All of these changes should reduce the company's cost of capital over the long term, making growth easier to achieve.
ONEOK's newest project plans. Image source: ONEOK, Inc.
On the growth front, ONEOK has $450 million of growth projects lined up for 2018 with committed customers backing the spending. That said, it has another $3 billion in projects in the wings, but it won't start work until it has secured customer commitments. The end goal is to increase the dividend at a 10% clip through 2021.
There's a little more risk at ONEOK than at Magellan, but you're being paid for that by a higher yield and higher dividend growth rate. Like Magellan, ONEOK is a worthy alternative to A. O. Smith if you are searching for a mixture of high yield and dividend growth.
Living off your income
There's no question in my mind that A. O. Smith is a great company with an incredible history of success. But that doesn't mean it's a great stock for every investor. If you're looking to maximize income today, it just doesn't pay to own a stock with a yield that's below 1%. But if you're willing to step down a notch on disbursement growth, Magellan and ONEOK are two well-run alternatives with hefty yields, strong operating histories, and solid prospects for continued growth.
