If you are looking for attractive income stocks, here are two energy giants you’ll want to buy and one to be leery of.
The energy sector is known for being volatile, given that oil and natural gas are commodities. But there’s one niche in the energy sector that tends to be far less volatile — the midstream. Yet all midstream companies are not created equal.
If you are looking for an ultra-high-yield investment, consider midstream giants Enterprise Products Partners (EPD 0.03%) and Enbridge (ENB 0.61%). Meanwhile, you’ll probably want to avoid Energy Transfer (ET -0.18%) if you want a reliable income stream.
Why is the midstream different?
The upstream segment of the energy sector is filled with companies that produce oil and natural gas. Given that the prices of these commodities can fluctuate wildly over time, the revenue that upstream companies bring in is highly volatile. It costs a lot to drill for oil and natural gas, so falling energy prices can often lead to red ink.
At the other end of the energy business is the downstream, which is filled with refiners and chemical companies. They have two problems to deal with, given that their primary inputs (oil and natural gas) are volatile and their outputs (like gasoline) can also be highly volatile commodities.
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In between the upstream and the downstream is the midstream, which is filled with companies that own energy infrastructure, such as pipelines, storage, processing, and transportation assets. Midstream companies usually charge fees for the use of the energy infrastructure they own and, thus, the price of oil and natural gas is less important than the demand for these vital fuels. Demand tends to remain robust even when energy prices are low.
That’s why even conservative investors can feel comfortable investing in midstream stocks despite the inherent volatility of the broader energy space. However, investors who are looking to use the income they generate from their portfolio to pay for living expenses still have to be very picky.
Enterprise, Enbridge, and Energy Transfer
From a big-picture perspective, Enterprise Products Partners, Enbridge, and Energy Transfer all own massive portfolios filled with vital energy infrastructure in North America. That’s a great starting point. Enterprise’s yield is 7.1%, Enbridge’s is 7.4%, and Energy Transfer’s is 7.8%. The first important factor here is that, given the huge yields and toll-taker business model, the yield is going to make up the lion’s share of an investor’s return. That will likely be fine with most income investors, but it is important to understand.
The second big takeaway is that income reliability shouldn’t be taken for granted. For example, Enterprise has increased its distribution for 25 consecutive years. Enbridge has increased its dividend for an even more impressive 29 years. And Energy Transfer cut its dividend in half in 2020.
There was a huge amount of uncertainty in 2020 when the world was getting hit hard by the coronavirus pandemic. Economic closures were being used to slow the spread of the illness and energy prices tanked (dramatically falling below zero at one point in the U.S. market). An investor could easily forgive Energy Transfer for taking steps to ensure its business would survive in an uncertain market. And the distribution is now above where it was before the cut. But in 2020 investors would have been forced to deal with a drastic reduction in income from what they may have assumed was a reliable dividend stock.
You need to dig deeper than yield
Yes, the midstream sector tends to be an energy niche where investors can find reliable high-yield dividend payers. But you can’t just buy any midstream stock. You need to focus on the ones that have proven over history that they can survive through the cycle and keep paying well all along. Enterprise and Enbridge pass that test. Energy Transfer does not. There’s more to know about both Enterprise and Enbridge before you buy them, of course, but if income is your goal, it is very clear that Energy Transfer just isn’t an income stock you can count on.
Reuben Gregg Brewer has positions in Enbridge. The Motley Fool has positions in and recommends Enbridge. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
