Most dividend investors will stop and take notice of Enterprise Product Partners' (EPD 0.45%) hefty 7.9% distribution yield. That's high on an absolute basis and a relative one, compared with the miserly 1.6% yield you'd get from an S&P 500 index fund today. The best part, however, is that this energy stock allows investors to sidestep the energy price volatility inherent in the sector it serves. Here's why it's a no-brainer for passive income investors.
The core of the business
Enterprise is a midstream master limited partnership (MLP). This is a business structure designed to pass income on to investors via large distributions. There are some tax considerations here, but if you are trying to create a passive income stream to supplement your Social Security payments, it is a name you'll want to look at. The key is that it doesn't produce oil, it simply helps to move it.
Image source: Getty Images.
That sounds boring (it is), but it is a vital part of the energy sector. Essentially, Enterprise acts as a toll taker, collecting fees for the use of its pipelines, storage, processing, and transportation assets. The demand for energy is more important than the price of the commodities moving through its vast system of North American infrastructure assets. Notably, what Enterprise owns would be virtually impossible to replicate, giving it a very strong industry position.
To emphasize the strength of the MLP's business, it has increased its distribution annually for 24 consecutive years. That's a very impressive streak when you consider the inherently cyclical nature of the energy sector. And, with a market cap of roughly $50 billion, it is easily one of the biggest names in the midstream space.
How safe is that yield?
That's all well and good, but here's the really interesting part of the story. Enterprise was able to cover its distribution by 1.8 times in the third quarter. To put that another way, the partnership's distributable cash flow could fall dramatically and it wouldn't impact the ability to keep paying the distribution. Or, conversely, Enterprise could increase the distribution without putting the payment at risk.
That's buttressed by an investment-grade-rated balance sheet. There are two factors here that are notable. First, credit rating agencies only give investment-grade ratings to entities they believe are financially strong. Second, being investment grade means that Enterprise will generally be able to access the debt markets with relative ease. So, if there were an industrywide problem, it would be in an advantaged position to survive the headwinds.
Access to capital, however, will also help the partnership continue to grow its distribution. That's because it will help to keep interest expenses down as Enterprise works on the $5.5 billion worth of capital investments it has planned. As these investments come online over the next four years, they will add to the partnership's cash flow. And that should lead to continued distribution growth.
So much to like
All of the positives here make Enterprise something of a no-brainer investment for conservative dividend investors. The only downside is that Enterprise is kind of a boring, slow-growing name in the energy patch where the distribution will likely represent most of the return the investment offers. But if your focus is creating a strong passive income stream, well, that "negative" is probably going to be a huge positive.
