Master limited partnerships, or MLPs, are all the rage these days. There's good reason for this, as MLPs can be an effective asset class for generating strong income, due to their unique tax classification. MLPs don't pay income tax, provided they distribute the vast majority of their cash flow to investors. This results in large distributions and high yields across the asset class, and has attracted the attention of income investors.
Among MLPs, midstream oil and gas partnerships are extremely popular because of their stability. These companies operate oil and gas pipelines and storage terminals, and are highly coveted for their "slow-and-steady" structure. They operate like toll roads, collecting fees based on transportation volumes. This means their cash flow is much more reliant on volumes than on underlying commodity prices. As a result, the midstream MLPs have not been hit nearly as hard as many other oil and gas businesses by the oil crash.
Two of the best-known midstream MLPs are Enterprise Products Partners (NYSE:EPD) and Magellan Midstream Partners (NYSE:MMP). What follows is a head-to-head matchup between these two midstream giants to determine which is the better buy for income investors.
Distribution yield: Enterprise Products
Perhaps the most important number for income investors is distribution yield. This expresses how much income an investor will earn, as a percentage of his or her investment. In this case, Enterprise Products and Magellan Midstream yield 4.6% and 3.4%, respectively. That's more than a full percentage point in Enterprise Products' favor.
This might not seem like a huge difference, but consider this: A $10,000 investment in Enterprise Products would generate $460 per year in income. By comparison, that same investment in Magellan would earn $340 annually. That means an investor gets 35% more income from Enterprise Products for each dollar invested. For this reason, Enterprise Products gets the nod when it comes to current income.
Distribution growth and coverage: Magellan
However, investors with even a moderate time horizon should consider the future, not just the present. In that regard, it's important to gauge how much income will be generated years from now.
Over the past five years Enterprise Products has increased its quarterly distribution by 5% compounded annually. Meanwhile, Magellan has raised its distribution by 14% compounded annually. This difference can have a meaningful impact over time. At this rate, Magellan's distribution will double every five years, while it would take more than 14 years to double your income from Enterprise Products. For this reason, Magellan handily beats Enterprise Products on distribution growth.
The reason for such a significant discrepancy is that Magellan's underlying cash flow is growing much faster than Enterprise Products'. In 2014 Magellan grew distributable cash flow by 31% to $880 million, due largely to increased shipments on its Longhorn pipeline. Enterprise Products grew distributable cash flow by just 8% in 2014, to $4.1 billion.
This will impact their future distribution growth. Magellan is planning a 15% distribution raise this year, along with at least a 10% increase in 2016.
Better pick? It depends on your needs
Both Magellan and Enterprise Products are large, highly profitable midstream energy companies. They both generate significant cash flow, which they use to reward their investors. Which one is a better buy depends on your particular needs. Given its significantly higher current yield, investors who need current income might consider Enterprise Products a better choice. It will pay you more right now.
However, those with a longer time horizon should consider Magellan. It is growing cash flow much faster than Enterprise Products, which in turn will likely lead to higher distribution growth as well.
Bob Ciura 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.