Investors have bailed on pipeline stocks in recent years due to all the turbulence in the energy market and the issues these companies have had with building new pipelines. However, one of the benefits of the pipeline stock sell-off is that it has pushed dividend yields higher. Because of that, there are a lot of attractive options for income investors these days.
Three energy stocks that stand out for their yields are Enterprise Products Partners (EPD -0.61%), Kinder Morgan (KMI -1.48%), and Williams Companies (WMB -0.73%). Here's why we think they're great options for dividend investors these days.
Image source: Getty Images.
A big yield from a fee-based business
Reuben Gregg Brewer (Enterprise Products Partners): If you like dividends, you need to take a close look at master limited partnership Enterprise Products Partners and its fat 10% distribution yield (the highest level in over a decade). The partnership is one of the largest midstream players in North America, with a diversified collection of pipelines, storage, processing, and transportation assets that would be nearly impossible to replicate. The best part is that roughly 85% of its gross margin is derived from fees for the use of these assets. In other words, commodity prices aren't nearly as important as demand for the products Enterprise helps transport. Demand for energy is expected to remain robust for years to come.
EPD Financial Debt to EBITDA (TTM) data by YCharts
That brings up Enterprise's ability to keep paying that huge distribution. In the second quarter, which was materially impacted by COVID-19-related supply/demand disruptions, the partnership managed to cover its distribution by 1.6 times. That gives ample room for adversity, noting that, historically, 1.2 times coverage is considered good. Moreover, Enterprise's balance sheet has long been conservatively managed, with financial debt to EBITDA at the low end of its industry peers. Oh, and the distribution has been increased annually for 23 consecutive years. There really is a lot to like here, assuming you can stomach the uncertainty in the energy space today.
Boring and predictable for all the right reasons
Daniel Foelber (Kinder Morgan): Kinder Morgan is a pipeline giant that's instrumental in transporting natural gas throughout North America. The company's stock is down 32% year to date (YTD) due to lower oil and gas prices and fears that future demand for oil and gas will be less than it is today. Kinder Morgan thinks this impact will only affect its 2020 earnings by about 9% thanks to its reliance on long-term contracts.
Unlike the short-term commodity price risk inherent in the upstream side of oil and gas -- which includes exploration, drilling, and production -- 98% of Kinder Morgan's cash flow comes from take-or-pay (68%), fee-based (24%), or hedged (6%) contracts.
|
Contract Type |
Payment Feature |
|---|---|
|
Take-or-pay |
Entitled to payment regardless of commodity prices or volumes |
|
Fee-based |
Entitled to a fixed fee on volumes regardless of commodity prices |
|
Hedged |
Locked-in commodity pricing |
Data source: Kinder Morgan.
These pricing structures can provide Kinder Morgan and other natural gas leaders reliable cash flow regardless of commodity prices or transport volumes. However, Kinder Morgan is still vulnerable to long-term trends affecting natural gas prices or demand when it comes time to justify building a new pipeline or write new contracts.
As with any stock purchase, some main attributes to focus on are the management, the brand, and the balance sheet. I think Kinder Morgan's management has come a long way since brutally cutting the company's dividend by 75% in late 2015. Management was keen to note that its priorities are now the balance sheet and the dividend, not mergers and acquisitions and growth at all costs. Kinder Morgan is going to be a lot more boring than it was five years ago, but that could be a good thing for income investors who want a company that produces reliable cash flow and is now more focused on paying and growing its dividend. Kinder Morgan yields 7.3% at the time of this writing.
Plenty of gas to sustain this 7.5%-yielding dividend
Matt DiLallo (Williams Companies): Williams Companies' natural gas pipeline operations generate lots of steady cash flow because long-term contracts and government-regulated rates support its revenue. Despite all the turbulence in the oil market this year, Williams expects to generate about $3.2 billion in cash, which is right about the mid-point of its initial guidance range.
The company currently expects to pay out about 60% of that money to support its 7.5%-yielding dividend. That leaves it with nearly $1.3 billion in excess cash. With capital spending expected to be about $1.1 billion this year, it can cover both outflows with room to space, which will provide it with some free cash to bolster its already solid balance sheet.
Meanwhile, Williams Companies' cash flow should grow in the coming years thanks to planned and potential expansions across its natural gas pipeline systems. It already has $2.2 billion of projects lined up at its key Transco system that should come online by 2023. On top of that, several new oil and gas fields in the Gulf of Mexico are on track to start up in the 2022 to 2024 timeframe, which will bolster its results from that region. Finally, it sees continued growth from the gas fields it services in the Northeast as producers there meet rising demand. Because of these factors, Williams should have plenty of fuel to grow its already high-yielding dividend in the future. That combination of a rock-solid yield with ample growth potential makes it an ideal option for income-seeking investors.
