The broader energy sector has been a bit volatile of late, with oil prices driven higher and lower by the latest coronavirus news. However, overall, oil prices and oil stocks have staged a material rebound since the drilling industry's pandemic downturn in 2020. One niche in the energy space that's still not feeling much investor love, however, is the midstream space. And investors looking for solid companies with big yields would do well to dig into Enterprise Products Partners (EPD -0.41%), Magellan Midstream Partners (MMP), and Enbridge (ENB 1.68%).
1. The bellwether
One of the first names that comes to mind when investors think of midstream investments is usually Enterprise Products Partners, a $46 billion market cap North American master limited partnership (MLP). Its collection of pipelines, storage, transportation, and processing assets would be virtually impossible to replace. And, like the other two names here, it largely gets paid for the use of its assets, so commodity volatility isn't a huge deal. And with demand for oil and natural gas likely to remain strong for decades to come, thanks to growing global demand for energy, there's no reason to expect Enterprise's systems to suddenly run on empty. That fact remains true even as clean energy investment ramps up, since it will take many years for these options to displace oil and natural gas.
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Enterprise currently yields a historically high 8.4% backed by a distribution that has been increased annually for 23 consecutive years. The MLP covered its distribution with distributable cash flow by 1.7 times in the third quarter as well, so there's ample leeway for adversity before the payment would be at risk. That said, with clean energy investment on the upswing, growth is a big question mark. Historically, ground-up construction of oil & gas infrastructure has played a big role, but now that's less certain. So look for Enterprise to be more acquisitive and for distribution growth to be a bit on the low side (think low single digits at best). However, with a huge yield, that probably won't upset income-oriented investors looking for a broadly diversified, and cheap, energy investment.
2. Focused on oil
Magellan Midstream Partners is another MLP, but is much smaller with a market cap that's just under $10 billion. Unlike Enterprise, Magellan has a fairly concentrated business focused on transporting and storing oil (about 30% of operating margin) and refined products (70%) like gasoline. Its fortunes are tied far more tightly to the ups and downs of the economy because of that, given that demand for refined products tends to ebb and flow with economic activity. While it largely fee-based business still avoids the ups and downs of commodity prices, the economic shutdowns related to the pandemic in 2020 depressed demand for its midstream assets because demand for refined products fell. That left investors worried about the partnership's ability to support its distribution. In fact, as it started 2021, the company was projecting distribution coverage of just 1.1 times, which is cutting it pretty tight compared with the coverage levels at Enterprise. However, thanks to the economic reopenings, coverage is now expected to be a touch over 1.2 times. That's the MLP's long-term target.
What's interesting about Magellan is that its distribution yield is a huge 9.1%, easily at the high end of its historical range and even higher than what you'll get from Enterprise. And that distribution has been increased annually every year since Magellan's initial public offering in 2001. Indeed, despite the headwinds it faced in 2020, it has continued to prioritize distribution growth. One of the key reasons it was able to do this is that Magellan has long focused on maintaining a strong balance sheet, noting that its financial debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio is usually at the low end of the industry. Don't look for massive distribution growth here (though the MLP did recently initiate a large share buyback as a way to return value to investors), but so long as refined products are in demand, Magellan's business should remain resilient.
MMP Dividend Yield data by YCharts
3. Expanding its reach
The last name up is Canada's Enbridge, with a $76 billion market cap and a historically high 7.1% dividend yield. Like Enterprise, it is one of the largest midstream names in North America, with a massive portfolio of fee-driven assets. However, it's not exactly a pure play. Roughly 14% of EBITDA comes from a natural gas distribution business, which is a utility operation, and 3% comes from contract-based renewable power assets. The natural gas distribution operation is benefiting from the switch to the cleaner-burning fuel, which is often cheaper and more convenient for customers, from dirtier alternatives like heating oil. And the company's renewable power investments give it a toehold in the area that could, eventually, displace demand for its midstream services.
What's interesting here is that Enbridge is generating a huge amount of cash today, expecting to have around $2 billion in excess cash flow in 2022 above its current investment plans. That's money that can be used to grow the business (potentially including more clean energy investment), strengthen the balance sheet, or be returned to investors via dividend growth and stock buybacks. Given the high yield today, dividend growth is likely to be modest since investors aren't rewarding the company for its fat payout. However, Enbridge is in Dividend Aristocrat territory with 26 years of annual dividend increases under its belt and no sign that this trend is going to change. So, if the yield were to come back down toward more historical levels, it wouldn't be shocking to see Enbridge shift distribution growth higher again. For investors looking to hedge their energy bets against a clean energy future, Enbridge is a good, cash-rich option.
The unloved niche
In the grand scheme of the energy sector, midstream assets are pretty boring. That's actually part of their allure for dividend investors, however, because they are highly reliable businesses. Right now, Wall Street is more focused on clean energy than reliable oil-tied businesses, even though there are likely to be decades of demand ahead for midstream companies. If you can think past the groupthink that often drives stock prices, Enterprise, Magellan, and Enbridge are all high-yield energy options that look very cheap today.
