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My Top High-Yield Stock to Buy in July

By Matthew DiLallo – Jun 29, 2020 at 11:33AM

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Overblown fears have this energy stock yielding more than 10% these days.

Enterprise Products Partners (EPD -0.25%) has been an elite dividend stock over the years. The energy master limited partnership (MLP) has increased its distribution for 21 straight years, which is quite a feat considering all the volatility in the oil market.

Despite its track record of success and strong financial profile, investors have lost confidence in the company. Overall, the MLP's unit price has plunged more than 35% this year, pushing its yield above 10%. 

I think the fears are overblown. That's why Enterprise tops my list of income stocks to buy this July.

A person holding a bag with the word dividends on it.

Image source: Getty Images.

Why all the worry?

The main factor weighing on Enterprise this year is the slump in oil prices. On one hand, the company doesn't have much direct exposure to commodity prices as long-term fee-based contracts underpin 80% to 90% of its earnings. However, it does have some volumetric exposure. Overall, take-or-pay contracts or minimum volume commitments support 45% to 55% of its fee-based earnings, while more durable sources like storage supply another 20% to 30%. This implies that 15% to 35% of its fee-based earnings have some exposure to volumes. 

That's a concern since many producers in the U.S. shut in unprofitable wells as crude prices crashed earlier this year. While some have restarted their pumps, others are taking a more cautious approach. This production impact will affect Enterprise's cash flow this year, since it won't collect as many fees on services tied to volumes.

Lots of margin for error

Despite that impact, Enterprise's earnings should still hold up reasonably well this year, since the majority comes from stable sources. There's not much risk that the company will need to reduce its distribution, since it has an exceptionally strong financial profile.

For starters, it paid out only 56% of its cash flow from operations during the first quarter to support both its high-yielding distribution and its unit repurchase program. That allowed it to retain more than $1.1 billion in cash. On top of that, the company has a strong investment-grade credit rating backed by a conservative leverage ratio, which stood at 3.3 times debt-to-EBIDTA. Because of those factors, Enterprise Products Partners has lots of flexibility to finance expansion-related spending.

Meanwhile, the company has bolstered its flexibility during the current market downturn by opting not to increase its distribution in the first quarter and reducing its capital spending plan. While the distribution growth pause halted a streak of 62 consecutive quarterly increases, the company felt it was a prudent move to make amid the pandemic.

It also chose to defer about $1.1 billion in capital projects, which will reduce this year's spending plan to between $2.5 billion and $3 billion. The company already funded $1.1 billion of this during the first quarter, entirely with excess cash flow. Meanwhile, with $2 billion of cash on hand and $8 billion of total liquidity, it has more than enough flexibility to finance its remaining capital spend as well as an upcoming $1 billion debt maturity. The company is also negotiating to potentially bring on additional joint venture partners, which could offload a portion of its financing commitments. That would further reduce concerns that the company might need to reduce its payout to finance growth.  

With a well-covered payout, ample liquidity, and a strong balance sheet, Enterprise Products Partners does not need to reduce its distribution. Instead, the company is more likely to start increasing it again later this year once oil market conditions stabilize.

An ultra-high yield with a low-risk profile

Usually, a dividend yield in the double digits is a sign of trouble. However, in Enterprise Products' case, it seems as if the market has overreacted since its payout is on one of the firmer foundations in the energy sector. Because of that, it's my top high-yield stock to buy this July. I even plan to reinvest all the dividends I receive last month into this top-notch dividend stock.

Matthew DiLallo owns shares of Enterprise Products Partners. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.

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