Imagine owning an investment that offers three times the dividend yield of an S&P 500 index fund and the potential to grow your income stream at rates higher than inflation. While that sounds like a dream come true, it really isn't that hard to find. And it doesn't require taking on huge financial risks. In fact, midstream energy bellwether Enterprise Products Partners (NYSE:EPD) and Magellan Midstream Partners (NYSE:MMP) both sport distribution yields of more than 6% today backed by solid businesses. Here's what dividend investors need to know to pick between these two income stocks.
1. It's limited
Enterprise and Magellan are both master limited partnerships. This is a corporate structure designed to pass income through to unitholders. You are, effectively, a "partner" in the entity and must report your portion of the overall partnership's results to the U.S. government based on a special form, a K-1, that you will get at tax time.
This is an important part of the reason why these two limited partnerships offer such high yields. But there are other factors to consider when looking at this type of entity, including the fact that limited partnerships come with other tax complications. For example, they don't play well with tax-advantaged retirement accounts. In fact, you might want to consult with a tax specialist before jumping in. But, if you are OK with a little extra legwork for a lot of extra yield, Enterprise and Magellan are two great names to look at.
2. They're committed
Although limited partnerships distribute a lot of income by design, Magellan and Enterprise stand out from the pack for their commitment to unitholders. Enterprise, for example, has increased its distribution every year for 22 years. Within that streak, it has increased the payout for 61 consecutive quarters (and counting). Magellan has "only" increased its disbursement for 19 consecutive years, but has done so every quarter since its IPO in 2001. So it's a narrow race. For reference, Magellan yields roughly 6.1% and Enterprise around 6.4%.
3. Is bigger better?
With a market cap of $60 billion, Enterprise is one of the largest energy companies in North America and is a bellwether in the midstream space. Its assets span almost the entire spectrum, including pipelines, storage, processing facilities, transportation, and ports. If you want broad exposure to the midstream space, Enterprise is a great way to get it. However, the partnership's large size means it takes more to move the needle on the top and bottom lines. Large capital investments and big acquisitions are important for growth and a constant issue to monitor, since such investments can be time consuming and/or uneven.
A $15 billion market cap makes Magellan a sizable entity in the industry, but it also means that smaller deals can still be meaningful to long-term growth. This partnership is largely focused on pipelines, with a relatively small storage footprint (roughly 7% of operating margin). Over the longer term, investors could reasonably expect Magellan to have an easier time expanding its business. This advantage has historically shown up in the distribution growth rates, with Magellan's annualized distribution growth rate over the past decade coming in at roughly 10% compared to Enterprise's 5%. That's a big difference, though the gap is likely to narrow a bit from here (more on this below).
4. Safety is key
Another thing that sets these two names apart from peers is their conservative approach to financing. Although there are multiple ways to dissect their balance sheets to show this, the debt debt-to-EBITDA ratio is a key industry metric. Enterprise's debt is around 3.2 times EBITDA, which is toward the low end of the peer group. Magellan's is even lower at 2.3!
Another key stat to examine is distribution coverage, which provides a gauge of how safe the distribution is. On that score, Enterprise wins hands down with distribution coverage of roughly 1.7 through the first six months of 2019. This is partly the result of the company slowing down its distribution growth into the low single digits so it can free up more cash to invest in growth projects. Management made that decision to avoid selling new units to fund such investments, which ends up diluting unitholders. Long-term distribution growth should pick back up into the mid single digits following a brief transition period.
Magellan's distribution coverage ratio is 1.2. Don't worry about the lower number here -- 1.2 is generally considered strong in the midstream space, and it's more than high enough to allow for increases over time. At the end of the day, both are solid names that mix conservatively financed, fee-based operations with a generous helping of income -- and income growth.
5. Where are they going?
While limited partnerships are great because they pass through much of their income to unitholders, that presents a problem in another way. As noted, Enterprise is shifting its business model so it can self-fund more of its growth. That makes it an even safer investment, but highlights the fact that partnerships must continue to build or acquire new assets if they want to grow. Without a steady stream of new income-producing assets, it gets much harder to keep growing the distribution. On that score, Enterprise has $6 billion worth of investments under development that will take it through 2020 or so. There's no particular reason to worry about its growth plans, and it is highly likely that distribution growth will tick back up to the mid single digits fairly soon.
Magellan is a bit of a wildcard right now. This year, it has roughly $1.1 billion in spending planned. That's well above normal -- the partnership hasn't invested more than $800 million in any other year over the past decade. That's great news for 2019, but Wall Street tends to look forward. Magellan has canceled a number of big growth projects recently and hasn't come up with notable replacements yet. In fact, its 2020 plan currently calls for just $150 million in spending, which is lower than any of the last 10 years.
That said, Magellan has a long history of successfully growing its business and deserves the benefit of the doubt. In fact, it has been stressing to investors that it has projects in the wings that could be worth as much as $500 million. That would be close to average for the partnership. One of the important issues is that Magellan prefers to have customers lined up before it breaks ground. That reduces project risk and is worth the extra effort, and near-term uncertainty, as management looks for new investment opportunities. The fly in the ointment is that Magellan has lowered its distribution growth guidance to the mid single digits, a reminder that capital spending and distribution growth are intrinsically connected.
And the winner is?
Having taken a quick look at Magellan and Enterprise, you might come away with the feeling that either one would be a reasonable income stock to add to your portfolio. Each has pros and cons, but both are generally pretty good partnerships. That is, in fact, the biggest takeaway. Still, if you prefer to stick with large and diverse companies, then Enterprise should get the nod. If, on the other hand, you prefer smaller businesses that may be able to grow distributions faster, then Magellan would be the one to pick. But, honestly, you probably wouldn't go wrong with either of these high-yielders.