Oil, natural gas, and many of the products they get turned into are commodities. The price of these commodities can swing dramatically and quickly, which makes the overall energy sector highly volatile. One smart way to deal with that volatility is to buy a high-yield diversified giant like Chevron (CVX -0.37%). But there's another avenue you can go down that offers even more income.
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What's so great about Chevron?
Chevron is a large and globally diversified integrated energy company. That means that it has exposure to energy production (the upstream), energy transportation (the midstream), and to chemicals and refining businesses (the downstream). That creates important diversification and, essentially, it provides investors exposure to the entire energy industry in one investment.
The key is that each segment of the industry operates a little differently. For example, when oil prices are low, the upstream will perform poorly. But the downstream uses oil as an input, so weak oil prices can boost downstream performance. The end result is that operating as an integrated energy giant helps to soften the peaks and valleys inherent to operating in the energy sector.
Given Chevron's 38-year streak of annual dividend increases, it is a solid choice in the energy sector for dividend lovers. Add in the roughly 4.4% dividend yield, and it also offers a relatively lofty income stream. For reference, the S&P 500 index is yielding just 1.2% today and the average energy stock has a yield of 3.2%.
Chevron is, indeed, a good choice if you want direct exposure to oil and natural gas. That said, it is worth noting that Chevron's highly volatile bottom line makes the dividend payout ratio a less useful tool when assessing dividend sustainability. The real story is the board of directors' commitment to the dividend, which can change at any time.
That is why the one segment of the energy industry that hasn't been mentioned in detail yet, the midstream, is worth discussing now. This segment of the industry generally operates with a toll-taker model, so the price of oil and natural gas isn't nearly as important as energy demand. And that's why the best high-yield energy investment you can buy today could be Enterprise Products Partners (EPD 0.32%).
What's so great about Enterprise?
Compared to Chevron, Enterprise, which is a master limited partnership (MLP), is downright boring. It owns one of the largest portfolios of energy infrastructure assets in North America. Like many of its peers, it mostly just charges other companies fees for moving oil, natural gas, and the products get turned into through its system of pipelines, storage, and transportation assets. Since demand for energy tends to remain high even when commodity prices are low, Enterprise's business is a fairly consistent cash flow generator.
That is the story behind Enterprise's 27 consecutive annual distribution increases. Backing that streak up, and supporting the distribution, is an investment grade-rated balance sheet. Adding even more security to the distribution is the fact that distributable cash flow covers the distribution 1.7x over. A lot would have to go wrong before Enterprise's distribution was put at risk.
So Enterprise's distribution has been basically just as reliable as Chevron's dividend. Enterprise's business model is more stable than Chevron's business model. And in the key piece of the story, Enterprise's roughly 7% distribution yield is much higher than Chevron's 4.4% yield. Basically, more yield for less inherent business risk. That will probably sound like a win for most income investors.
There's one notable drawback with Enterprise
A $10,000 investment in Enterprise Products Partners will get you around 315 units or so of the MLP. That said, what you won't get is a fast-growing business. The yield will make up the lion's share of your total return over time. This, however, shouldn't be a big deal for investors who are focused on maximizing the income their portfolio generates.
