The winds of change have ravaged the master limited partnership (MLP) space this year. A combination of higher interest rates and an unexpected policy change have hit some MLPs hard while leaving others virtually untouched. Because of that, investors need to dig much deeper into a company before investing in this space.
That's evident when comparing Spectra Energy Partners (SEP +0.00%) with Enterprise Products Partners (EPD +0.11%). While both appear to have solid financial metrics, the upheaval in the industry makes one clearly the better buy for investors seeking an income-generating stock for the long term.
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A quick look at the numbers
At first glance, Spectra Energy Partners looks like a more compelling option for income-seeking investors:
| Company | Dividend Yield | Credit Ratings | Debt-to-Adjusted EBITDA | Projected 2018 Dividend Payout Ratio | % of cash flow fee-based or regulated |
|---|---|---|---|---|---|
| Spectra Energy Partners | 9.6% | BBB+/Baa2/BBB | 4.1 times | 1.15 times | 100% |
| Enterprise Products Partners | 6.1% | Baa1/BBB+ | 4.1 times | 1.3 times | 90%+ |
Data source: Enterprise Products Partners and Spectra Energy Partners.
As that table shows, the company offers a much higher yield even though its financial metrics appear just as strong as Enterprise's numbers. Because of that, many investors would quickly conclude that it's the better buy.
However, there's much more to this story if investors dig a little deeper.
The change no one saw coming
The difference-maker came this past March when the Federal Energy Regulatory Commission (FERC) changed its long-standing policy that had allowed MLPs to recover an income tax allowance as part of the cost-of-service rates they charged on some pipelines. It came in response to a court ruling that stated FERC "failed to demonstrate there was no double recovery of income tax costs" when it allowed MLPs to recover both an income tax allowance and a return on equity when setting pipeline rates.
The policy change will only impact pipelines owned by MLPs that derive their revenue from cost-of-service fees. In Spectra Energy Partners' case, 40% of the revenue it collects on its gas pipelines has this type of rate structure. The other 60% of revenue from its gas pipelines, as well as 100% of the income from its liquids pipelines, comes from negotiated or market-based tariffs, which were not affected by the policy change. For comparison's sake, only a minimal amount of Enterprise Products Partners' earnings comes from cost-of-service fees. That's because the company has a much more diversified revenue stream due to its vast portfolio of processing assets, storage terminals, and export facilities that are all backed by long-term, fee-based contracts. As a result, the company will feel little to no impact from this change.
Spectra Energy Partners initially thought that it wouldn't see any immediate impact on its revenue as a result of the policy change and that it could take steps to mitigate the effect in future years. However, the MLP's majority owner, Canadian energy infrastructure giant Enbridge (ENB 0.54%), recently stated its view that Spectra Energy Partners will face challenges as it seeks to mitigate the FERC ruling. Because of that, Enbridge believes Spectra Energy Partners will need to reduce its high-yielding payout as early as next year. That's why Enbridge no longer thinks Spectra Energy Partners is viable as a stand-alone MLP, which led it to recently make an offer to acquire the company, as well as its other publicly traded entities.
The great unknown versus the sure thing
Spectra Energy Partners has yet to agree to that transaction. Because of that, investors are in a state of uncertainty. If the company signs the deal, investors will receive shares of Enbridge in exchange for their MLP units. At the current exchange rate and yields of the respective companies, investors who buy today would likely see a payout reduction from Spectra's current 9.6% yield down to around Enbridge's 6.7% rate. Acceptance of the deal would also likely have some impact on investors' income taxes. On the other hand, if the company chooses to go it alone, the distribution cut could be even deeper.
Because of all the uncertainty surrounding Spectra's future, it's not an ideal option for income-seeking investors to consider buying, since they'll either eventually own Enbridge or see a significant payout reduction. While Enbridge is a great option for income investors since it expects to increase its dividend at a 10% annual rate over the next few years, it would make more sense to buy its stock outright instead of purchasing Spectra.
That uncertainty makes Enterprise Products Partners the clear better buy between these two. However, that's not because it's the lesser of two evils but because it's a great company with a bright future. As noted earlier, it has strong financial metrics, which include one of the top credit ratings among MLPs. Meanwhile, Enterprise is on the pathway to self-fund growth with excess cash flow, which will make it a much safer investment in future years. These factors help support the view that Enterprise's 6.1% payout will likely continue rising in the years to come, making it an excellent option for income-seeking investors to buy and hold for the long haul.
