If you're looking for stocks with high dividend yields that are safe, the midstream energy sector is a great place to start your search. The energy industry has transformed itself since the last big energy bust. Producers are no longer chasing production growth and instead are more focused on their cash flows.
Pipeline companies, meanwhile, have improved their balance sheets and learned to grow within their cash flow. Energy prices and their impact on volumes are always a risk, but with both pipeline companies and their customers in solid financial shape, now is a great time to invest in the sector.
Let's look at three high-yield pipeline stocks to invest in right now. I currently own all three and have for a long time.
Image source: Getty Images.
1. Energy Transfer
With a 7.3% forward yield and plans to increase its distribution by between 3% to 5% a year moving forward, Energy Transfer(NYSE: ET) is a stock that should be on every income-oriented investor's radar. After being forced to cut its distribution in half during the height of the pandemic when the economy effectively shut down for a short time, the company has worked hard to lower its leverage, improve its balance sheet, and restore its distribution to a level that is now above where it was before the cut.
Last quarter, Energy Transfer proclaimed that its balance sheet was in the strongest position in its history. It also noted that it had its highest-ever percentage of take-or-pay contracts, which means that it gets paid on these agreements regardless of whether or not customers use its services. Overall, it expects 90% of its earnings before interest, taxes, depreciation, and amortization (EBITDA) this year to come from fee-based services, where it has no exposure to fluctuating commodity costs or spreads. These types of contracts add to the safety of its cash flows and, thus, distributions.
Meanwhile, the company sees a lot of attractive growth opportunities ahead stemming from increased natural gas demand. It is ramping up its growth capital expenditure (capex) this year to $5 billion from $3 billion, with an expectation of mid-teens returns on its projects. Energy Transfer has already signed a deal to supply natural gas to a planned data center in Texas and continues to explore artificial intelligence (AI) related opportunities.
Trading at a forward enterprise value (EV)-to-EBITDA multiple of just 8.1 times, the stock is also cheap both on a relative basis and on a historical basis.
2. Enterprise Products Partners
If there is one midstream stock you can sleep well owning, it's Enterprise Product Partners(NYSE: EPD). The company has increased its distribution every year for the past 26 years through various energy and stock market turmoil. At present, the stock sports a 6.8% forward yield after increasing its distribution by nearly 4% year over year last quarter.
The company takes a conservative approach and has one of the best balance sheets in the midstream sector. Like Energy Transfer, it also has a largely fee-based business and includes take-or-pay provisions in its contracts when it can. It also carries a robust coverage ratio based on its distributable cash flow (operating cash flow minus maintenance capex), which stood at 1.7 times last quarter.
Like Energy Transfer, it has increased its growth capex spending this year to take advantage of attractive opportunities. After reducing its growth project spending to only $1.6 billion in 2022, it plans to spend between $4 billion and $4.5 billion this year, up from $3.9 billion a year ago. It currently has $6 billion in growth projects set to come online this year, paving the way for solid growth over the next couple of years.
Trading at a forward EV/EBITDA ratio of under 10 times, the stock is attractively valued.
3. Western Midstream Partners
Western Midstream Partners (NYSE: WES) is an income-oriented investor's dream. The stock has a robust 9.4% yield and plans to grow its distribution by mid-to-low single digits annually. It ended last year with leverage of under 3 times, which is very low for a midstream company, so it's in strong financial shape.
The company's contracts generally have cost-of-service protections and/or minimum volume commitments (MVCs). MVCs require a customer to ship a minimum volume of product -- such as natural gas, natural gas liquids (NGLs), or crude -- through its pipelines or pay as if they did. Like take-or-pay contracts, they help ensure future cash flows and mitigate risk against volume declines.
It's not pursuing as much growth as either Energy Transfer or Enterprise, but it is looking for safe, high-return organic growth projects that are supported by MVCs. It said it is in close contact with its customers and can quickly reduce or increase its capex based on their needs. In the event it can't find attractive growth projects, it said it could consider acquisitions or stock buybacks.
The stock is a good value, trading at a forward EV/EBITDA ratio of 9 times 2025 analyst estimates.
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Geoffrey Seiler has positions in Energy Transfer, Enterprise Products Partners, and Western Midstream Partners. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
