Why Stocks Like Kinder Morgan and Enterprise Products Have Such Attractive Dividend Yields

Energy infrastructure companies Enterprise Products Partners (EPD 0.48%) and Kinder Morgan (KMI 0.27%) pay whopping yields. With respective dividend yields of 7.5% and 6.3%, all you would have to do is hold the stocks for 13-15 years, and even without dividend growth the accrued dividends would mean the stocks pay for themselves. As such, they are no-brainer stocks to buy.

However, investing isn't as easy as that, and investors need to look at all sides. Here's the lowdown.

Why these stocks carry such high yields

The first obvious but accurate thing to say is that these companies generate the earnings and cash flow to enable them to pay these generous dividends. As you can see below, by comparing free cash flow (FCF) per share with dividends per share, Kinder Morgan has consistently generated the FCF to cover its dividend in recent years. While that hasn't been the case with Enterprise Partners, its dividend is well covered. 

As a reminder, FCF is what's left from earnings after working capital (the cash required to run the business) and capital expenditures (used to maintain and grow the business) are taken out. In other words, the yearly flow of cash can be allocated to pay down debt, make acquisitions, or return money to investors in the form of share buybacks or dividends. 

Data by YCharts

It's worth adding that the FCF generation has picked up partly because of a paucity of new investment in the oil & gas industry in response to the dramatic fall in the price of oil in 2015 and the long-term threat from renewable energy. As such, both companies have cut back on capital spending -- helping to boost cash flow. 

Data by YCharts

What the market is afraid of with Kinder Morgan and Enterprise Products Partners

The second thing to note is that investors are so worried about these companies' long-term prospects that they aren't willing to buy them unless they have high yields. But there's always a reason why a stock carries a high yield, and it usually makes sense to address that reason and be comfortable with it before buying the stock. 

The critical question is whether the earnings necessary to generate the FCF to fund these dividends are sustainable over time. The answer to that question lies in your view of the so-called "clean energy transition," wherein renewable energy is seen as replacing fossil fuels in the economy. 

Image source: Getty Images.

It's a key point because there's no doubt that both energy infrastructure companies are plays on the movement of fossil fuels in the U.S. economy.

As you can see in the following tables, both businesses wouldn't exist without fossil fuels, and their prospects are bleak without them. First, here's Kinder Morgan.

Data source: Company SEC filings. 

Now, Enterprise Product Partners. 

The end of fossil fuels?

And here is where the market's concern lies. The following table shows the International Energy Agency's (IEA) outlook for North American oil and gas demand. It shows the 2021-2030 period being roughly flat, and then demand declining from 2030-2050. That period may seem a long time away, but consider the argument the article started with -- North American oil and gas demand will likely decline before the 13 to 15 years are up. In addition, dividends will probably be cut if North American oil and gas demand volumes decline.

There's an opportunity to export oil and gas, and the IEA's forecasts do assume a slight pickup in oil and gas demand ex-North America from 2030-2050. , it's highly doubtful whether an increase in export demand is likely offset a decline in North America to an extent that both companies' dividends are sustainable at this level.

Data source: World Energy Outlook 2022. mb/d=million barrels per day, bcme=billion cubic meters of natural gas equivalent.

Are the stocks worth buying?

Ultimately, your view on this comes down to what you think about the "clean energy transition." Many things can happen between now and 2030, let alone 2050, and forecasting that far ahead is uncertain. Moreover, there's no understating of the importance of energy security, a concern that might lead to a change in policy. In addition, as noted earlier, under the IEA stated policies scenario, oil & gas demand is expected to rise outside of North America to 2050, so export demand should provide some support. 

In addition, fossil fuels aren't just used for energy, they are used across a wide range of indispensable products (plastics, resins, rubber, fertilizer, paint, etc.) in the global economy, and renewable energy remains an intermittent energy source. 

On balance, I think Kinder Morgan is worth picking up for income-seeking investors, as the market does seem to be pricing in a pessimistic scenario (which you shouldn't ignore before you buy the stock).  However, for the reasons touched on above, it's unclear if the energy transition will work out as planners think.