If you're an income-oriented investor, you've undoubtedly come across Energy Transfer (ET -0.42%) and Enterprise Products Partners (EPD 0.23%), two high-yielding midstream stocks. The question on many investors' minds is: Which is the better stock to own right now? I think Energy Transfer is the better stock to own, but I own both stocks, and the answer to the question is a bit more nuanced depending on your own situation.
Both stocks have attractive yields, with Energy Transfer carrying around a 7.2% yield and Enterprise at 6.8%, as of this writing. However, I think Energy Transfer is the better stock to own right now because it offers more potential upside. That said, for investors who care more about downside protection than upside potential, Enterprise is probably the better option for you.
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Similarities and differences
Energy Transfer and Enterprise have a lot of similarities. They are both structured as master limited partnerships (MLPs) and own two of the largest midstream systems in the U.S. Both companies have tightly integrated systems that can gather, process, store, transport, and export hydrocarbons. They also have strong presences in the Permian Basin and along the Gulf Coast in Texas and Louisiana.
Now, there are differences in their systems. Energy Transfer has more geographic breadth across the country, while Enterprise is more concentrated along the Gulf Coast and Texas. Energy Transfer, meanwhile, operates one of the largest natural gas pipeline systems in the country, while Enterprise is the dominant player in natural gas liquids (NGLs).
Both companies lean heavily into fee-based activities, which protects their cash flows from fluctuations in energy prices and commodity spreads. However, neither is afraid to take advantage of arbitrage opportunities. They also like to structure their contracts with take-or-pay provisions, which means they get paid whether or not a customer uses their services, as well as inflation escalators. This all helps provide visibility to their cash-flow streams.
Historically, Enterprise has been the much more conservative of the two companies. It likes to keep its leverage low and support its distribution with a high coverage ratio. This has helped the company increase its distribution every year for the past 26 years, including through some very tough economic and energy price periods.
Admittedly, Energy Transfer has not been as good on this front. It had to slash its distribution in half during the pandemic after it got a bit over its skis with its leverage. However, the strength of its operations allowed it to quickly deleverage and restore its distribution to pre-pandemic levels within two and a half years. Today, the company's distribution is the highest it's ever been (split adjusted), and management recently said the company was in the best financial shape in its history.
Both companies are also seeing strong growth project demand at the moment. After reducing its growth capital expenditure (capex) to just $1.6 billion in the wake of the pandemic, Enterprise plans to spend between $4 billion to $4.5 billion this year, up from $3.9 billion last year. The company also has $6 billion in projects slated to come online this year, which should help boost growth. Much of this is centered around the NGL value chain and the Permian.
However, Energy Transfer has historically been the more aggressive company when it comes to pursuing growth projects, and it raised its growth capex budget from $3 billion last year to $5 billion this year. Much of its efforts will also be around the Permian. One of its largest projects is a pipeline that will take associated gas away from the Permian to support growing natural gas demand in Texas.
It is the company's expansive natural pipeline system, meanwhile, that is helping the company see increasing interest in projects related to artificial intelligence (AI). It signed its first AI-related deal with data center developer Cloudburst to directly provide natural gas to its newest data center development in Texas. Meanwhile, it has been getting a lot of inbound interest from data center operators and power companies to provide new connections to support growing energy demand stemming from AI. Given its more robust natural gas pipeline system, Energy Transfer should have more AI-related opportunities in front of it compared to Enterprise.
A cheaper stock with a higher yield
In addition to having more growth opportunities ahead, Energy Transfer is also the cheaper stock and carries a higher yield.
From a valuation standpoint, Energy Transfer trades at a forward enterprise value (EV)-to-EBITDA multiple of just 8.2 times compared to 9.9 times for Enterprise. Both of those multiples are below historic MLP valuations, as the group had an average EV-to-EBITDA ratio of 13.7 times between 2011 to 2016.
Energy Transfer also carries the slightly higher yield, and both stocks look poised to grow their distribution in the 3% to 5% range moving forward. While Enterprise has historically had the higher distribution coverage ratio, based on distributable cash flow (operating cash flow minus maintenance capex), that is no longer the case today. Last quarter, it had a coverage ratio of over 2, while Enterprise's was at 1.7. However, Enterprise's leverage does remain lower.
Taken altogether, given its track record, I think Enterprise is the safer stock, but I think, given the valuation difference and more growth opportunities in front of it, Energy Transfer is the better stock to own with more upside potential.
