Pipeline stocks can be attractive investments, especially for income seekers. That's because pipelines typically produce predictable cash flow backed by long-term contracts, giving their owners the funds to pay high yielding dividends.

Besides that income, many pipeline stocks also boast attractive growth prospects due to the need for new midstream infrastructure in North America. While the continent already has the world's largest energy pipeline network, it needs more capacity to meet the expected growth in supply and demand over the next several years.

According to a forecast by the INGAA Foundation, which represents the natural-gas pipeline industry, North America needs to spend $44 billion per year through 2035 on new energy infrastructure like pipelines. Because of that, companies that operate pipelines should be able to grow at a healthy rate.

That growth should allow the top companies to increase their already above-average dividends. Given that dividend growth stocks have historically outperformed the market, the best pipeline stocks could generate market-beating total returns.

This guide will walk investors through the pipeline companies best positioned to grow their dividends in the coming years. Those growing income streams increase the likelihood that these stocks will outperform over the long term, making them a great buy opportunity.

Pipelines heading towards the bright sun.

Image source: Getty Images.

How to find the best pipeline stocks

Pipeline stocks struggled in the years following the collapse of oil prices in late 2014. That's evident in the performance of the Alerian Energy Infrastructure ETF, which is an exchange-traded fund (ETF) that holds both U.S. and Canadian pipeline stocks as well as master limited partnerships (MLPs). This ETF lost nearly 13% in the five years following that downturn. While the ETF's total return improved to 4% after adding in dividends, that significantly trailed the S&P 500's more than 90% total return over that five-year span.

Several pipeline stocks, however, have delivered much better performance over the years. One thing that has separated the outperformers from the laggards is their ability to consistently grow cash flow and their dividend. Two factors played a significant role in enabling these companies to steadily increase their payout: an excellent financial profile and a strategically focused asset base.

We'll start by looking at the four characteristics that help determine the strength of a pipeline company's financial profile:

Predictable cash flowMost pipelines produce very stable cash flow backed by long-term contracts. Where these companies tend to get into trouble is when they operate other related assets that have direct exposure to volatile commodity prices. Some natural gas processing plants, for example, buy gas directly from producers, process it to extract the natural gas liquids (NGLs), and then sell the two streams for a higher price. The margins from these activities tend to rise and fall with commodity prices.  Because of that, investors should focus on pipeline companies that get more than 80% of their revenue from stable sources.

An investment-grade credit rating. Because pipeline companies pay above-average dividends, they often need to borrow a lot to finance expansion projects. It's cheaper and easier to obtain this funding if they have an investment-grade credit rating.

A low leverage ratioA low leverage ratio goes together with an investment-grade credit rating since it supports that outlook. Ideally, a pipeline company should have a debt-to-EBITDA ratio of less than 5.0 times, with many aiming to keep that metric below 4.0.

A conservative distribution coverage or dividend payout ratio. Pipeline companies typically pay out a higher percentage of their cash flow in dividends than most other stocks do. Those high payout ratios, however, have burned the industry in the past, especially for companies with outsized direct exposure to commodity prices and elevated leverage ratios. Because of that, investors should look for pipeline stocks that can cover their dividend with cash flow by at least 1.2 times, which works out to about an 80% payout ratio. The best pipeline stocks aim for even more-conservative coverage closer to 2.0 times, or a 50% payout ratio.

In addition to those financial characteristics, the best pipeline companies also have high-quality assets in the top regions. For example, they'll operate long-haul transmission pipelines backed by minimum volume contracts in an area with lots of running room for producers to continue expanding their output. That strategic focus on the fast-growing areas increases a pipeline company's ability to expand its operations, cash flow, and dividend.

The top pipeline stocks to buy now

Most pipeline companies will meet some of those characteristics. Few, however, boast having a top-tier financial profile while also operating large-scale positions in the best regions. The five that meet both criteria are on the following table:

Top pipeline stocks to buy

Future growth drivers

Enbridge (NYSE:ENB)

Oil and natural gas pipeline expansions in the U.S. and Canada.

Enterprise Products Partners (NYSE:EPD)

Export projects along the U.S. Gulf Coast.

Kinder Morgan (NYSE:KMI)

Natural gas infrastructure projects.


Natural gas liquids infrastructure.

Williams Companies (NYSE:WMB)

Natural gas pipelines.

Data source: Company investor presentations.

Here's a closer look at why these five pipeline stocks seem to have what it takes to outperform over the next several years.

A pipeline with a snow covered mountain in the background.

Image source: Getty Images.

1. Enbridge: North America's energy infrastructure leader

Enbridge operates three dominant franchises: liquids pipelines, gas transmission, and gas utilities. Its core business is operating the world's longest, most-complex crude oil pipeline system, which transported 25% of all the oil produced in North America in 2019. The company complements that industry-leading system with a large-scale gas transmission business that transported 18% of all the gas consumed in the U.S. in 2019. And it operates the largest natural gas utility in North America.

Enbridge has done an excellent job leveraging its infrastructure empire to create value for investors over the years. Through 2019, the Canadian pipeline company had increased its dividend for 24 consecutive years. Over that time, its payout grew at an 11% compound annual rate. This consistent dividend growth helped Enbridge generate an astounding total return of 2,750% over that 24-year period, which pulverized the S&P 500's 654% total return during that time frame.

Enbridge probably won't continue beating the market by such a wide margin given its massive size as the largest energy infrastructure company in North America. However, it should be able to continue delivering excellent results for its investors in the coming years.

The first factor driving that view is Enbridge's history of having a strong financial profile. In 2019, for example, the company got 98% of its earnings from predictable sources like long-term, fee-based contracts and only paid out 65% of its cash flow to support its dividend. And it has a solid investment-grade credit rating backed by a conservative leverage ratio comfortably within its 4.5 to 5.0 target range.

Enbridge's healthy financial profile gives it plenty of flexibility to invest in expanding its portfolio. It should have no shortage of opportunities to grow since North America needs to invest an estimated $44 billion per year through 2035 on new energy infrastructure. The company believes it can fund CA$5 billion to CA$6 billion ($3.8 billion to $4.6 billion at July 2019's exchange rate) of expansion projects per year. At that investment level, it could grow its cash flow per share at a 5% to 7% annual rate. That pace could support similar yearly increases in the dividend. Given that Enbridge's dividend typically yields around 6%, it could produce total annual returns in the 11% to 13% range.  

With a strong financial profile and no shortage of expansion opportunities, Enbridge should continue creating value for its investors in the years to come.

2. Enterprise Products Partners: The liquids export king

Enterprise Products Partners is one of the largest master limited partnerships (MLP) in the midstream sector. From its IPO in 1998 through the middle of 2019, the company had invested $42 billion on organic expansion projects and another $26 billion on acquisitions. These investments allowed it to build out an integrated system to transport, process, store, and export a variety of energy commodities. 

And they have paid big dividends for investors over the years. As of mid-2019, the pipeline MLP had increased its distribution every year since its IPO. That steadily rising payout helped fuel an impressive total return of more than 2,000% over that time frame, which easily outperformed the S&P 500's 290% total return during the same period.

One key factor in Enterprise Products Partners' outperformance is its history of maintaining a conservative financial profile. The MLP typically gets more than 80% of its earnings from predictable sources like long-term, fee-based contracts. Meanwhile, it has aimed to keep its coverage ratio above 1.2 times, with its margin of safety reaching 1.6 in 2018. The company complements those metrics with a top-notch balance sheet. That includes one of the highest credit ratings among MLPs, which it backs with a leverage ratio that's historically below 4.0 times debt-to-EBITDA.

Enterprise Products Partners' healthy financial profile gives it the flexibility to invest in expansion projects. In 2019, the company had more than $5 billion of expansions under construction and another $5 billion to $10 billion in development. While these expansions included oil, natural gas, and NGL pipelines, one of the MLP's biggest growth drivers is its export business.

The company operates a premier hydrocarbon export facility along the Houston Ship Channel, which makes it a leader in shipping things like crude oil and propane. That strategic footprint has it well positioned to continue expanding its export capabilities in the coming years. In Enterprise's view, America's crude oil exports alone are on track to grow from 2 million barrels per day (BPD) in 2018 up to 8 million BPD by 2025. As the company builds more export capacity -- and additional pipelines to move oil and gas to the Gulf Coast -- its cash flow should continue increasing.

That rising cash flow should give it the resources to continue growing its distribution to investors, which has been the key to its outperformance over the years. With Enterprise Products Partners' dividend historically yielding about 6%, it could deliver total returns in the double digits assuming it grows cash flow by a mid-single-digit annual rate.

3. Kinder Morgan: Perfectly positioned for natural gas

Kinder Morgan is the largest natural gas pipeline company in North America. In 2019, it transported 40% of all the gas consumed in North America through its 70,000-mile system. In addition, it is the largest transporter of refined petroleum products and carbon dioxide as well as the largest independent storage-terminal operator.

On the one hand, Kinder Morgan has had trouble leveraging these industry-leading positions to create value for investors. After growing its dividend for the first few years after its IPO in 2011, the company slashed its payout in 2015 due to crashing oil prices. It needed to conserve cash after its leverage ratio grew above the comfort level of credit rating agencies, which had it on the verge of losing its investment-grade rating.

Kinder Morgan, however, learned its lesson and has become much more fiscally conservative. In 2019, the company got 90% of its cash flow from stable sources but only paid out about half that money via its dividend. That's a significant improvement from its payout ratio in 2015, which was over 90%. Meanwhile, the company's credit profile has improved. In 2019, it boasted a solid investment-grade credit rating backed by a 4.5 leverage ratio, which was right at its target level.

The pipeline company's improving financial profile gives it the flexibility to invest in expansion projects. In the company's view, it can spend $2 billion to $3 billion per year on growing its portfolio. At the low end, that investment level is enough to increase its earnings by 4% per year. With the company's dividend typically yielding more than 4%, Kinder Morgan could produce total annual returns of at least 8%, with more upside if it grows at a faster pace.

The company should have no problem securing enough projects to grow its business. According to the industry's forecast, gas demand in the U.S. will grow by more than 30% from 2019 through 2030. About 70% of that will be in Texas and Louisiana (where Kinder Morgan has a dominant position) as companies build more downstream petrochemical plants and liquified natural gas (LNG) export terminals. Meanwhile, America is on track to produce a quarter of the world's gas by 2025, and account for more than half of the supply growth. Those factors lead Kinder Morgan to believe that it can leverage its strong financial profile and strategic position to grow at a healthy pace for years to come.

4. ONEOK: Focused on NGLs

ONEOK is among the largest midstream companies in North America. It operates one of the nation's premier NGL systems and is a leader in the gathering, processing, storage, and transportation of natural gas. 

One factor that sets ONEOK apart from others in the sector is its focus on building infrastructure to capture liquids-rich natural gas in places like North Dakota's Bakken Shale. The company starts by building pipelines that gather the natural gas and NGLs produced alongside oil. It then transports them to processing facilities. The gas then goes into the country's interstate pipeline system while the NGLs head off to other facilities for further processing before making their way to the petrochemical sector. By focusing on this niche, ONEOK is turning an afterthought into a valuable commodity for its customers. That's enabling it to make lots of money expanding its NGL-focused operations.

The company has done an exceptional job of capitalizing on that niche to create value for its investors over the years. While ONEOK did press the pause button on dividend growth during the oil market downturn from 2015 to 2017, it has managed to increase its payout in most years. That has helped create tremendous total returns for investors throughout its history. In the decade from July 2009 through that same month in 2019, it produced a nearly 700% total return. That's more than double the S&P 500, which generated a 285% total return over that time.

The pipeline company has been able to grow its cash flow and dividend over the years by ensuring that it maintained a strong financial profile. In 2019, it had a solid investment-grade credit rating backed by a leverage ratio of around 4.0. Meanwhile, it got about 90% of its cash flow from predictable sources and covered its dividend by more than 1.4 times.

That sound financial profile gives ONEOK the flexibility to invest in growth projects. In 2019, it has more than $6 billion of expansions under construction. It anticipates that those projects will grow its cash flow at a double-digit annual rate through 2021, which would support similar increases in its dividend. With its dividend typically yielding about 5%, ONEOK could potentially produce total annual returns of around 15% over that time.

5. Williams Companies: Operating America's fastest-growing gas pipeline

Williams Companies is one of America's largest gas pipeline operators. It transported 30% of the country's natural gas in 2019 through its 30,000-mile system. The crown jewel of its portfolio is the Transco system, which is the country's largest gas pipeline by volume. 

Williams, like Kinder Morgan, struggled to maximize the value of its leading pipeline system in previous years. It had an aggressive financial approach that put it in a tight spot when the energy market started crashing in late 2014. That ultimately forced the company to reduce its dividend so that it could retain more cash, which it used to pay down debt and finance expansion projects.

But Williams learned from its mistakes, and it has a much-improved financial profile. In 2019, the company got nearly 97% of its earnings from predictable sources like fee-based contracts, while it covered its dividend with cash flow by 1.7 times. Meanwhile, it had an investment-grade balance sheet, backed by a 4.5 leverage ratio.

Those healthy finances give Williams Companies the flexibility to expand its pipeline system. One of its focus areas is further increasing the capacity of its Transco system. Williams raised the system's capacity from 8.5 billion cubic feet per day (Bcf/d) in 2008 up to 16.7 Bcf/d in 2018 by supporting supply growth from the Marcellus shale and increased demand along the Eastern Seaboard. The company aims to get Transco's capacity up to 18.9 Bcf/d by 2022 as it continues expanding that system.

The continued growth of Transco and Williams' other systems should enable the company to increase its earnings at a 5% to 7% annual rate over the long term. That should support dividend growth at around the same pace. Add the growth rate to Williams' dividend, which has typically yielded at least 5%, and the pipeline stock could produce total annual returns in the 10% to 12% range.

What make these pipeline stocks great long-term buys

These stocks all have a bright future. First, each one pays a high-yielding dividend backed with sustainable financial metrics. On top of that, they should be able to grow their cash flow and dividend at a healthy pace for the next several years. Add the dividend income to the earnings growth rate, and these stocks could produce total annual returns in the double digits, which should be enough to beat the market. This potential for above-average returns over the next several years is what makes these five pipeline stocks the best ones for the long haul.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.