MLPs are great ways to earn large and growing income and have proved to be capable of market-obliterating total returns. High-quality midstream MLPs -- those involved in pipelines, processing, and storage -- such as Enterprise Products Partners (NYSE:EPD) have long track records of beating not only the market but also their industry peers, as represented by the Alerian MLP index, but also of increasing income to investors. In the case of Enterprise Products Partners it has raised its payout for 40 consecutive quarters. 

EPD Total Return Price Chart
EPD Total Return Price data by YCharts

Let's examine four reasons why Enterprise Products Partners is one of the highest-quality growth investments you can make today that offer high-yield distributions in a tax-advantaged dividend.

Quality management

Investments aren't just slips of paper or numbers on a computer screen, but rather ownership stakes in a business. That's the reason investing alongside a management team that can be trusted--backed up by a long track record of wise investor-wealth-building decisions--is so important. I'm confident that Enterprise Products Partners' management team is deserving of your trust and confidence for three primary reasons. 

MLP Operating Margin Return on Assets Return on Equity
Enterprise Products Partners 7.40% 6.80% 18.70%
Energy Transfer Partners (NYSE:ETP)  3.80% 0.10%  0.20% 
Magellan Midstream Partners (NYSE:MMP) 40.80% 15.80% 46%
Industry Average 9.70% 2.70% 9.30%

Source: Morningstar.com.

Enterprise Products Partners has proved itself capable of building unitholder wealth thanks to high margins and some of the finest profitability in its industry. Particularly I'd like to draw your attention to Enterprise's Return on Assets (ROA) and Return on Equity (ROE), which are more than double the industry average at more than 68 times greater than competitor Energy Transfer Partners. Return on Assets, also called return on investment, represents how good a company or partnership is at converting its investable capital (from both debt and equity) into net profits. Return on Equity represents how well management can generate net income from money given to them by investors. Both metrics are a good way of quickly evaluating the health of an MLP.

MLPs are designed to pay out the majority of cash flows as distributions. Thus, to grow they need to take on debt and sell additional equity. ROE can tell you how well management can convert those new shares, which dilute your ownership stake, into profits that benefit you through higher distributions. However, ROE can be inflated if an MLP takes on massive debt, so ROA is a good way of confirming that management is capable of generating good returns from both funding sources.

No general partner means management is working harder for you

In 2010, Enterprise bought out its general partner for $8 billion and in so doing became one of only five midstream MLPs without a general partner, or GP. This is a big benefit to investors because general partners hold incentive distribution rights, or IDRs, which grants them up to 50% of marginal cash flow once distributions reach a certain level. Thus the cost of capital is higher because the cost of equity is elevated by the need to pay both limited partners -- that is, regular investors -- and the GP. The lack of a GP's IDRs means that Enterprise is free to keep more of its cash flow for funding growth projects and acquisitions, or raising the distribution. Thanks to 36% insider ownership, management has a heavy incentive to do so.

Low cost of capital is a competitive advantage 

MLP Equity Funding Cost of Equity Debt Funding Cost of Debt Weighted Average Cost of Capital
Enterprise Products Partners 79.40% 8.5% 29.60% 3% 7.40%
Energy Transfer Partners 54.5%  8%  45.5% 3.1%  5.70% 
Magellan Midstream Partners 86.40% 8.20% 13.60% 3.40% 7.50%

Source: Bloomberg Intelligence.

Thanks to its massive scale and BBB+ investment grade credit rating, Enterprise has extremely low debt funding costs. Why does that matter? Because the WACC figure of 7.4% is based on previous years in which Enterprise was more dependent on equity issuances to fund growth. 

Over the past five years, though, 55% of the MLP's funding has come from debt, which has reduced its WACC to 5.48%, far below its average return on invested capital of 9.77%. 

That high profitability, along with a rock-solid distribution coverage ratio of 1.56, means that Enterprise is retaining enough of its cash flow to fund much of its growth organically without need for debt or equity issuances. In fact, over the past five years, Enterprise has funded 29% of its growth in this manner, a very high proportion in this capital-intensive industry.

Distribution safety

Finally, one of the most important aspects to any income investment is the safety of the dividend or distribution.

MLP Distributions as % of EBITDA Distributions as % of Operating Cash Flow Distribution Coverage Ratio
Enterprise Products Partners 47.43% 59.29% 1.56
Energy Transfer Partners 80.12% 113.43% 1.22
Magellan Midstream Partners 55.99% 65.17% 1.6

Sources: MLPdata.com, Morningstar.com, Yahoo Finance, author calculations

Enterprise Products Partners has one of the safest distributions of any of these MLPs and among the highest coverage ratios in its industry. A distribution coverage ratio greater than 1.1 indicates a safe payout that can grow sustainably, and while Magellan Midstream's ratio is higher than Enterprise's, there are two caveats to that figure.

First, they are a result of hedges that contributed to Magellan's cash flows this year and can't be relied upon to repeat in the future. Second, Magellan's management is more aggressive about growing its distribution and is targeting a 1.1 long-term coverage ratio.

Similarly a caveat also applies to Energy Transfer Partners, whose high distribution coverage is a result of five years of not raising distributions. Now that management has begun growing that MLP's payout once more, its guiding for a long-term payout ratio of approximately 1.05. Secure to be sure but nowhere near as bomb proof as that of Enterprise. 

Enterprise's management has historically been more conservative with its coverage ratio, which allows the MLP to fund more of its growth projects through retained cash flow and also provides distribution growth protection even during the most extreme of market and economic conditions. For example, Enterprise Products Partners was able to raise its distribution by 11.5% during the financial crisis of 2008-2009 even as credit markets dried up.   

Thus, investors are partially compensated for Enterprise's slower historical and projected distribution growth by the increased safety of the payout. Enterprise is thus especially well suited for retirees, though it shouldn't be owned in tax-advantaged retirement portfolios such as 401(k)s or IRAs because of tax complications associated with such accounts.  

MLP Yield Historic Distribution Growth Rate 5 Year Projected Distribution Growth Rate
Enterprise Products Partners 3.90% 7.95% over 18 years 6.96%
Energy Transfer Partners 6% 8.45% over 10 years 17.58%
Magellan Midstream Partners 3% 13.42% over 13 years 14.43%
S&P 500 1.88% 5.05% over 24 years 5.05%

Sources: Yahoo! Finance, Multpl.com, Fastgraphs.

Takeaway: income growth, blue-chip, rock-solid payout

Enterprise Products Partners represents one of the best managed MLPs in America. Its long track record of excellent management, rock-solid distribution safety, and competitive advantages such as a low cost of capital and lack of a general partner mean that all income investors should at least consider this MLP blue chip for a position in their diversified income portfolios.

 

Adam Galas has no position in any stocks mentioned. The Motley Fool recommends Enterprise Products Partners and Magellan Midstream Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.