It's conventional wisdom to avoid stocks with really high dividend yields. A company's yield increases when the market lowers its share price, signaling potential skepticism that the company can afford its dividend payments. These troublesome stocks are often called yield traps.
But there are exceptions to every rule, and you can find the occasional gem that can support its juicy dividend yield. For example, look to the oil and gas sector, where you'll find various types of business that have crucial differences -- but all revolve around extracting resources from the ground and moving them to where they are needed.
Here are two quality companies with generous yields and valuations that make them an easy buy today.
Lock in nearly 10% yields with Energy Transfer
Energy Transfer (ET +1.02%) is a midstream company that deals in transporting and storing fossil fuels like crude oil and natural gas. You can think of midstream or pipeline stocks as toll roads: Midstream companies like Energy Transfer charge a rate based on the volume flowing through their pipes.
The company is a master limited partnership (MLP). This gives it tax benefits but requires it to distribute most of its taxable income to unitholders as distributions. Consult a tax professional if you're unsure how MLP investments are taxed.
Next, let's talk about that distribution. Energy Transfer has a nearly 10% yield that gives investors a reasonably high floor for investment returns. More importantly, the business must be able to afford the distribution, a legitimate concern after Energy Transfer cut its payout during the pandemic. Fortunately, the company seems to be on solid footing today.
NYSE: ET
Key Data Points
Distributable cash flow -- the cash profits available to disperse -- was $2 billion in the first quarter, against total distributions of $967 million. That's a distribution payout ratio of roughly 50%, and the business is doing well enough that management raised its 2023 outlook.
Energy Transfer paid off $1 billion in debt this past quarter and has $3 billion in borrowing capacity. In other words, the company's financial footing looks strong enough that the dividend appears safe, but investors should look for any breakdowns in the future.
Energy Transfer hit record midstream volumes in the first quarter, bolstered by the company's completed $1.45 billion acquisition of Lotus Midstream. The company has a track record of acquisitions, and believes it's positioned to benefit from rising demand for propane and liquified natural gas exports over the coming years.
Valuing the stock, you can look at its distributable cash flow, which is the cash profits left after any investments to maintain the business. Considering the units trade at a price to distributable cash flow ratio of five, Energy Transfer appears to be a bargain with a significant yield worth scooping up.
Ride growing LNG exports with Kinder Morgan
Kinder Morgan (KMI +0.07%) is a diversified midstream company based in Houston. Its assets are spread throughout America, including 70,000 miles of pipelines that move 40% of natural gas produced in the United States. It also transports refined products and carbon dioxide and operates marine freight terminals and clean energy projects.
The stock's dividend yield is a robust 6.8% at the current share price. Kinder Morgan had increased its dividend for six consecutive years, rebuilding its dividend track record after the company slashed the payout in late 2015 when it faced high capital investment needs and a potential credit rating downgrade.
But that was the past, and this is now. Kinder Morgan is guiding for $4.8 billion in distributable cash flow (DCF) in 2023, meaning a dividend payout ratio of 53% based on the annualized dividend expense of $1.13 per share.
NYSE: KMI
Key Data Points
Rising American natural gas exports could significantly affect Kinder Morgan's growth over the coming years. Management is optimistic about its position in Texas and Louisiana, hotbeds for expected growth in natural gas exports.
Kinder Morgan has written contracts to grow its natural gas transport volume from 7 billion cubic feet per day (bcf/d) to 10 billion bcf/d by 2025, and is exploring another potential 10 billion bcf/d in open opportunities.
Fortunately, the market isn't giving Kinder Morgan much respect yet. The stock has a market cap of $37 billion, and given its $4.8 billion in expected distributable cash flow for 2023, the stock trades at a price to distributable cash flow of just under eight today. If Kinder Morgan is right about the long-term growth in exports, investors could be positioned to capture much of that growth as investment returns over the coming years.
Considering Kinder Morgan's strong financials, yield-hungry investors should look at tapping into its stock.
