When a company's dividend yield approaches the double digits, it means one of two things. Either the market believes the payout is at risk of a reduction, or the company trades at a wildly low valuation.
Energy Transfer (ET -0.19%) and Crestwood Equity Partners (CEQP) fall into that latter category. Because of that, these energy master limited partnerships (MLPs) look like ideal options for investors seeking lucrative passive income streams.
A nearly bottom-of-the-barrel valuation
Energy Transfer currently offers investors a 9% yield. That's several times above the 1.7% dividend yield provided by an S&P 500 index fund. Put another way, a $1,000 investment in Energy Transfer could generate $90 of annual passive income. Meanwhile, that amount would only produce $17 of dividend income if invested in the S&P 500.
That big-time payout is on an increasingly sustainable foundation. The company generated enough cash to cover its distribution by 1.93 times in the third quarter. That enabled it to produce $760 million of excess cash, which it used to fund expansion projects and reduce debt. Because of that, Energy Transfer is on track to end this year with a leverage ratio in its targeted range of 4 to 4.5 times debt to earnings before interest, taxes, depreciation, and amortization (EBITDA).
That solid financial profile means the payout is on a firm foundation. As such, the primary driver of that monster yield is the company's low valuation:
Image source: Energy Transfer Investor Relations Presentation.
As that chart shows, Energy Transfer currently trades at about 8 times its enterprise value (EV) to EBITDA. That's the second-lowest valuation among large-scale energy midstream companies and well below the peer-group average.
Given the improvements in its financial situation this year, Energy Transfer has been steadily increasing its payout. It gave its investors a 15% raise last quarter and has increased its payout by 70% over the past year. That's part of its strategy to return its payout to its former peak of $0.305 per unit each quarter. With the most recent distribution at $0.265 per unit, Energy Transfer needs to increase it by another 15% to achieve that goal. That likely growth makes it an extremely attractive option for income-seeking investors.
Only growing stronger
Crestwood Equity Partners' payout currently clocks in at 9.7%. Like Energy Transfer's distribution, this one is on an increasingly firm foundation.
The MLP generated enough cash to cover its payout by 1.9 times during the third quarter. That gave it the money to fund its expansion program with room to spare, allowing it to use the excess cash to repay debt. As a result, the company expects to end the year with a solid leverage ratio between 3.9 to 4.1 times.
Crestwood expects to produce between $780 million and $800 million of adjusted EBITDA this year. With its enterprise value recently at $6.6 billion, it trades at about a 8.4 EV-to-EBITDA ratio. That's right down there with Energy Transfer toward the bottom of the barrel in the energy midstream space.
Meanwhile, the company's massive payout will be on an even firmer foundation next year. Crestwood completed a slew of strategic transactions in 2022 to sharpen its focus on its core operations. It made several acquisitions in its core basins and exited two noncore regions. Those deals enhanced its scale, positioning it to generate meaningful and growing free cash flow in 2023 and beyond. That should enable the company to achieve its even more conservative long-term target of a 3.5 times leverage ratio. It would also give the company more financial flexibility to continue its consolidation strategy while increasing its distribution (Crestwood gave investors a 5% raise earlier this year).
Attractive income opportunities
Energy Transfer and Crestwood Equity trade at dirt cheap valuations. Because of that, they offer investors monster yields. Those big-time payouts are on an increasingly sustainable foundation as these MLPs use their gushing excess cash flows to finance growth and reduce debt. That makes them look like great options for investors seeking high-octane passive income streams.
