With the yield on the S&P 500 index at a scant 1.4% right now, investors are likely to have a hard time finding high-yield stocks. That said, the out-of-favor midstream energy sector is chock-full of stocks with fat yields. But you have to be selective, which is why your short high-yield list should start with this trio of industry-leading names.
1. Heavy on oil
Magellan Midstream Partners (MMP) is a master limited partnership (MLP) that operates in the oil (34% of operating margin) and refined products (64%) spaces. Roughly 85% of its top line is fee based, so it largely gets paid for the use of its assets; the commodity price of the products it is helping to move is much less important. The current distribution yield is a huge 8.8%, which is near the high end of its historical range, suggesting the units are cheap today.
The problem is that oil and products into which it gets turned are out of favor because of the fuel's carbon footprint, which could limit demand for Magellan's services and retard its long-term growth outlook. These are very real considerations; however, oil is likely to remain a key global energy source for years to come. And while transportation fuel, which is likely to get hit by the clean transition sooner than other areas, is a big part of the story for Magellan, vehicles are expensive assets with 10-year (or longer) life spans. That suggests Magellan's business will remain vital for many years even as the world goes green. And the MLP has a long history of being fiscally conservative, with a financial debt-to-EBITDA ratio toward the low end of the industry. So there's really no reason to be overly worried about its ability to survive the current headwinds. That said, its coverage ratio in 2021 will likely dip to around 1.1 times, which isn't great, but management remains committed to maintaining its distribution throughout the year. For those with a bit of risk tolerance, this is a solid high-yield name to consider while it works to muddle through the oil industry malaise.
2. More natural gas
Next up is midstream industry bellwether Enterprise Products Partners (EPD -1.07%), which is also structured as an MLP. It has a massive collection of largely fee-based pipelines, storage, processing, and transportation assets that spans across North America. Moreover, the products that move across its system are equally varied, but with a heavier focus on natural gas (about 60% of gross segment operating margin). This fuel is expected to help the world transition away from dirtier carbon fuels like coal. The company's historically high distribution yield of 7.7% is backed by 25 years of annual distribution increases (if you include the hike made at the start of 2021), making it a Dividend Aristocrat.
Like Magellan, Enterprise has a long history of operating in a conservative manner, with a financial debt-to-EBITDA ratio toward the low end of its peer group. The distribution here, however, is far more secure, with a coverage ratio of 1.6 times in 2020. This is a solid option for more conservative high-yield investors.
3. Similar but different
The last name on this list Kinder Morgan (KMI -0.31%), which is very similar to Enterprise with regard to scale and reach. However, Kinder is structured as a regular company, so there are none of the MLP tax issues to consider. There's two caveats here, however. First, the midstream giant has been improving its balance sheet in recent years, but its financial debt to EBITDA ratio of roughly 5.3 times is still toward the higher end of the industry. At this point the leverage issue isn't as worrisome as it once was, but really conservative investors might want to keep an eye on the issue just the same.
Second, Kinder Morgan cut its dividend 75% in 2016 just a couple of months after telling investors to expect a dividend increase. To be fair, it was the right choice for the company (which put the cash toward growth projects), but there's a trust issue there that shouldn't be overlooked even though the dividend is growing again. That said, in the first quarter of 2021 Kinder Morgan covered its distribution by a huge 1.8 times. So the dividend looks very secure right now even as the industry faces headwinds. In fact, the company decided to increase the payment by around 3%, rewarding investors for sticking around in these troubled times. If you don't want the complexity of an MLP, Kinder Morgan is strong candidate even though its 6.2% yield is a bit lower than the two names above.
High yields in a low-yield world
No investment is perfect, so dividend-focused investors looking for high yields need to be prepared to make some concessions today given the low market yield. However, if you can handle owning well-run companies in an out-of-favor niche like the midstream energy sector, then you can definitely find attractive yield options. Magellan carries the most headline risk here because of its ties to the oil industry. Enterprise Products has more of a natural gas emphasis. And Kinder Morgan offers a chance to own a high-yield midstream stock without the headache of the MLP structure. All three are worth a close look, since being on the outs on Wall Street has left them offering generous yields.