Investors looking for high yields would be remiss if they didn't dig into the midstream energy sector. But don't just buy any midstream business, because there are risky high-yield investments here, and some businesses have less-than-impressive histories.
Here are some examples of businesses to be leery of, and one high-yield midstream business worth buying and holding forever.
Some troubling things to consider
When you look at high-yield investments, you have to make sure you understand why the yields are so high. In the midstream space, yields are high across the board because the sector is largely focused on producing income for shareholders. So, generally speaking, midstream stocks usually have attractive yields. But not all high yields are created equally.
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For example, USA Compression Partners (USAC -1.42%) has a lofty 8.3% yield. But the business is run with more leverage than many other businesses in the sector. To put a number on that, the debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio is around 4.4x today. That's above the 3.7x of Energy Transfer (ET -0.42%), the business that is USA Compression Partners' general partner and, thus, runs it, and well above the 3.2x of Enterprise Products Partners (EPD 0.23%), one of the most conservative players in the midstream sector.
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What's interesting here is that Energy Transfer has a 7.3% yield, which is pretty attractive, too. But Energy Transfer cut its dividend in 2020 during the coronavirus pandemic. That was likely a time when most income investors would have preferred a little dividend consistency. Once again, there are problems with the income story that shouldn't be ignored.
This brings things back to Enterprise, which has the lowest yield of the three at 6.8%.
Enterprise has a record you can rely on
If you have $10,000 to put to work, do you want to invest in a highly leveraged business or one that cut its distribution when faced with adversity? You'll probably want to entrust your hard-earned savings to a business that has been a little more reliable. Note that Enterprise has long been conservatively operated and had an industry-leading debt-to-EBITDA ratio. Income investors are usually risk-averse, so buying Enterprise will keep you in your comfort zone on that score.
But there's more to the story. Enterprise has increased its distribution every year for 26 consecutive years. That streak includes increases during the pandemic, the Great Recession, and the dot-com crash. Being a reliable income investment is clearly something Enterprise prioritizes.
The distribution, meanwhile, is backed by an investment-grade-rated balance sheet. And Enterprise's distributable cash flow covers its distribution by a very strong 1.7x. There is a lot of leeway here before Enterprise would be at risk of a distribution cut. Given the $7.6 billion in capital investment projects underway, it seems far more likely that the slow and steady distribution increases will continue.
Last but not least, insiders own nearly a third of Enterprise Products Partners' units. So management is fairly well aligned with unit holders, which is backed up by the business being financially conservative and providing a steady, and growing, income stream.
If you are going to put your savings to work in an income investment, Enterprise is a very strong candidate, and one you can buy today and hold for the long term.
Enterprise checks a lot of boxes
To be fair, like most midstream businesses, Enterprise's yield is going to make up the lion's share of return here. But if you are an income investor, that probably won't bother you. And given all the positives, a $10,000 investment in this reliable and financially strong income producer seems like a pretty attractive long-term proposition for investors who like to buy and hold.
