When in search of high-yield dividend stocks, probably the greatest places to look is within the midstream energy space. A lot of these corporations are structured as master limited partnerships (MLPs), which go through their profits to their unitholders and as such don’t pay corporate taxes.
In consequence, most pay out very generous distributions, that are much like dividends, but much of the payout is taken into account a return of capital. This portion is tax deferred until the stock is sold and reduces the owner’s cost basis. It is a nice profit, even though it does add some paperwork come tax time.
The midstream sector as an entire has passed through quite a lot of changes over the past decade. Previously, corporations often had a structure of a general partner (GP) and limited partner (LP) that ultimately was more useful to the GP. The best way it worked was that GPs would own what are called incentive distribution rights (IDRs), while the LP would pay the GP a percentage of its distributions once they hit certain points.
This became very useful to the GP because once MLPs hit a 50/50 high split, the GP would get half of the incremental distribution payout. For instance, if an organization raised its distribution by $0.02 per unit and that was equal to $10 million (500 million units outstanding times $0.02), it will also must send the GP an extra $10 million under the IDR agreement. This structure also encouraged LPs to fund growth through issuing more equity, because the more units the LP had, the larger the dollar payments would also develop into.
By and huge, this structure has been eliminated, and MLPs are generally in higher financial shape in consequence, carrying less leverage and with the ability to grow their business through free money flow. Nevertheless, the stocks surprisingly trade at a reduction today in comparison with where they traded under the old, unfavorable model. Between 2011 and 2016, MLPs traded at a median multiple of 13.7 in enterprise-value-to-EBITDA (earnings before interest, taxes, depreciation, and amortization), probably the most common option to value these stocks.
Today, the businesses within the sector trade at much lower valuations despite the industry as whole being in a a lot better place. This — together with increasing power demand from artificial intelligence (AI) hardware in data centers — creates a wonderful buying opportunity. Let’s take a look at two great MLPs to purchase without delay.
Despite having a few of the perfect assets within the midstream space with its large integrated system, Energy Transfer(NYSE: ET) is certainly one of the most affordable MLPs within the space, trading at a forward EV/EBITDA multiple of 8.5. It currently has a forward yield of 6.4% and expects to extend its distribution by 3% to five% a 12 months.
Its distribution can be well covered, with a coverage ratio of 1.8 times last quarter based on its distributable money flow (operating money flow minus capital expenditures for maintenance). And it generated free money flow of over $165 million after paying distributions.
Energy Transfer also has a few of the perfect growth opportunities within the midstream space. This stems partially from its strong presence within the Permian Basin, giving it access to a few of the most affordable natural gas within the country. The Permian is primarily drilled for oil, and there have long been capability constraints for transporting the associated natural gas out of the basin. This results in very low-cost regional pricing and makes Texas an excellent area to construct data centers.
Energy Transfer also has the pipeline infrastructure to take natural gas from the Waha Hub in western Texas to numerous other locations. As such, it said last quarter that it saw inbound requests seeking to connect about 45 power plants in 11 states to its pipeline system and greater than 40 proposed data centers in 10 states.
The corporate also announced a latest $2.7 billion Permian gas takeaway project that it said will help support data center growth in Texas.
All in all, Energy Transfer combines an affordable stock with a strong, well-covered distribution trading at a historically attractive price.
Image source: Getty Images
Even through the days of the old MLP model, Enterprise Products Partners(NYSE: EPD) was all the time some of the stockholder-friendly corporations within the MLP space. It eliminated its 50% IDRs way back in 2002 in favor of a 25% high split after which completely eliminated them and collapsed its structure in 2011. The corporate has also all the time taken a more conservative approach with leverage and maintained a powerful balance sheet.
This has allowed the corporate to boost its distribution for 26 straight years through various economic and energy cycles. The stock currently yields 6.4% and trades at a horny EV/EBITDA multiple of 10.
The corporate is currently starting to ramp up growth given the opportunities it’s seeing. After reducing its growth capital expenditures (capex) to $1.6 billion in 2022 following the peak of the pandemic, it’s going to spend around $3.5 billion to $4 billion in 2024. The corporate has averaged a 12% annual return on its growth capex, which paves the way in which for strong EBITDA increases in the approaching years.
Enterprise Products Partners can be well positioned to profit from the increasing power needs related to AI and data centers with a powerful presence in Texas, especially across the cities of Dallas and San Antonio, each of which need to develop into data center hubs. The corporate said the facility demand coming from AI was some of the promising signals it has seen within the natural gas sector in an extended time, and that it had a few of the perfect assets to have the option to profit from this trend.
All in all, Enterprise Products Partners has shown itself to be a model of consistency and has quite a lot of opportunities while trading at a horny valuation.
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Geoffrey Seiler has positions in Energy Transfer and Enterprise Products Partners. The Motley Idiot recommends Enterprise Products Partners. The Motley Idiot has a disclosure policy.