1 ultra high yield energy stock to buy Hand Over Fist and 1 to avoid

Energy transfer (NYSE: ET) offers investors an ultra-high distribution yield of 8%. Enterprise product partners (NYSE: EPD) has a yield of 7.2%. Although both come from the midstream energy sector, they are not interchangeable investments. Here’s why the lower-yielding Enterprise is worth buying out of hand, and it’ll probably be better to avoid the power transfer.

The power transfer problem

When energy prices fell at the start of the coronavirus pandemic, Energy Transfer reduced its distribution by 50%. That 2020 distribution cut was probably justified by the uncertainty the world was facing at the time, but it certainly wasn’t the distribution outcome investors were hoping for. And while the distribution of the master limited partnership (MLP) has started to rise again and is actually higher than it was before the reduction, investors who care about income consistency should not ignore the choice it made -o management in 2020. This opens up a very real reality. the risk that the next downturn in the energy industry will lead to the same result.

However, a reduction in distribution in the face of energy industry adversity is understandable. What is harder to explain with Energy Transfer is the failed 2016 purchase agreement Williams Companies. The energy transfer started the business, but an energy downturn caused the MLP to go cold. Energy Transfer then worked to kill the deal, arguing that completing it would require taking on too much debt, cutting dividends, or both. The effort to get out of the deal included the issuance of convertible bonds, which is where the real problem comes in.

The CEO bought a large portion of the convertibles at the time. The security would have effectively shielded the CEO from the impact of a dividend cut if the deal had gone ahead as planned, leaving unitholders to feel the full brunt of a cut. It was a complicated business, but this is a higher-level and unsettling vision. That CEO, Kelcy Warren, is now “only” the chairman of the board, so there’s still good reason to be concerned about what happened nearly a decade ago.

Overall, if you’re looking for a reliable income stream, energy transfer is probably not the place to look.

Enterprise Products Partners continues to put unitholders first

Enterprise Products Partners is another large North American midstream MLP. But it doesn’t have the same cast negatives hanging over it. For starters, it has increased its distribution annually for 26 consecutive years. Second, he was able to make regular purchases without resorting to aggressive tactics in an effort to close a deal before it was completed.

But what’s interesting here is that the Enterprise is not immune to the impact of the power drop. While its business is largely based on fees, 2016 was a relatively difficult year, and so is 2020. The business has continued to roll forward despite the temporary weakness, and distribution has been increased despite this weakness. A key factor is the conservative nature of Enterprise’s management, with the distribution supported by an investment-grade balance sheet and a strong distribution coverage ratio (distributable cash flow currently covers distribution 1.7 times).

There is also a long history of decisions favorable to unitholders to consider. For example, in 2002 Enterprise reduced its incentive distribution rights by 50%, freeing up more cash to pay unitholders at the expense of the general partner. In 2007, management slowed distribution growth so it could invest more in expanding the business to increase long-term returns. In 2011, the MLP eliminated incentive distributions and bought out its general partner, effectively becoming a stand-alone entity. And in 2018, Enterprise worked to become a self-funding business so it wouldn’t have to issue as many dilutive units in the future.

Stick to the one you can trust

It’s not an exciting investment, but Enterprise has clearly thought about unitholders in a way that Energy Transfer hasn’t. If you’re trying to live off the income your portfolio generates, trusty Enterprise, despite a slightly lower yield, is probably the better option than Energy Transfer over the long term.

Should you invest $1,000 in Energy Transfer right now?

Before buying shares in Energy Transfer, consider the following:

The Motley Fool Stock Advisor the analyst team has just identified what they think they are 10 best stocks for investors to buy now… and Energy Transfer was not one of them. The 10 stocks that made the cut could produce monster returns in the coming years.

Consider when Nvidia made this list on April 15, 2005… if you invested $1,000 at the time of our recommendation, you would have $792,725!*

Stock advisor provides investors with an easy-to-follow blueprint for success, including portfolio construction guidance, regular updates from analysts, and two new stock picks every month. The Stock advisor the service has more than four times return of the S&P 500 since 2002*.

See the 10 stocks »

*The stock advisor returns starting August 26, 2024

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.

1 Ultra-High Yield Energy Stock to Buy Hand Over Fist and 1 to Avoid was originally published by The Motley Fool