Rising interest rates make turning idle cash into passive income much easier. Even low-risk options like bank CDs and government bonds are paying over 5% these days. That can enable investors to earn about $50 of income over the next year for every $1,000 they invest.
While that's a decent amount of money (especially compared to recent years), it might not be sustainable. If rates fall when those investments mature, investors will need to accept a lower payment when they reinvest that money.
Given that potential reinvestment risk, investors might want to consider taking on a little bit more investment risk and lock in a higher (and likely more sustainable) income stream. Energy Transfer (ET 0.12%) certainly fits the bill. The master limited partnership (MLP) currently offers an 8.8% yielding payout (implying it will produce about $88 of annual passive income for every $1,000 investment). Even better, the pipeline giant expects to steadily increase that payout.
A relatively low-risk, high-yielding payout
Energy Transfer operates a diversified energy midstream business. Its pipelines, processing plants, storage facilities, and export terminals generate reasonably predictable income. This year, roughly 90% of its projected earnings will come from stable fee-based sources. That gives it a nice foundation of steady cash flow.
The MLP currently pays out slightly more than half of its steady cash flow to investors via its high-yielding distribution. That allows it to retain billions of dollars each year that it can allocate toward other things:
Image source: Energy Transfer.
As that slide notes, Energy Transfer produces enough excess free cash to cover its entire growth capital spending program, leaving it with additional money for debt reduction or unit repurchases. That's giving it the flexibility to achieve a leverage ratio toward the lower end of its 4.0-4.5 target range. This reasonable range for a pipeline company supports its solid investment-grade bond ratings.
The company's combination of steady cash flow, relatively low payout ratio, internally funded capital program, and strong investment-grade balance sheet put its high-yielding distribution on a very firm foundation.
Visible growth
What sets Energy Transfer apart from other income alternatives like bonds and bank CDs is that it's not a fixed-income investment. The MLP set a target of increasing its quarterly distribution rate (currently $0.31 per unit) by $0.0025 per unit each quarter. That implies around a 3% to 5% annual growth rate.
Two factors fuel its growth: organic expansion projects and acquisitions. The company expects to invest about $2 billion this year on organic expansion projects, including a recently approved $1.25 billion expansion of its Nederland terminal that should enter service in mid-2025.
Over the longer term, the MLP anticipates spending between $2 billion and $3 billion per year on capital projects. CFO Tom Long noted on the MLP's second-quarter conference call that it has an "incredible backlog of growth opportunities." Several notable projects are under development, including Lake Charles LNG and a partnership with Occidental Petroleum related to its Magnolia carbon capture and storage hub. These and other potential expansion projects would grow the company's cash flow, giving it more fuel to increase its distribution. The Magnolia project is one of several alternative energy investment opportunities the company is pursuing as it seeks to capitalize on the transition to lower-carbon energy.
Energy Transfer is also an active acquirer. The company recently agreed to acquire fellow MLP Crestwood Equity Partners in a $7.1 billion deal. The transaction will be immediately accretive to its distributable cash flow per unit while providing opportunities for future cost savings. In addition, the MLP bought Lotus Midstream in a $1.45 billion deal earlier this year. That transaction was also accretive to its distributable free cash flow per unit.
Energy Transfer's dual growth drivers will supply it with incremental cash flow to increase its distribution. They'll also boost its excess free cash flow, giving the company more financial flexibility in the future.
A steadily rising passive income stream
Energy Transfer generates very stable cash flow, about half of which it distributes to investors via a very high-yielding payout. That enables it to retain lots of cash to finance its continued expansion while maintaining a strong balance sheet. The company's growth will give it the fuel to continue increasing its distribution. That consistent income growth makes it a smart option for those seeking to generate more investment income.
