With the return on the S&P 500 at just 1.4% right now, investors are likely to have a hard time finding high-yielding stocks. That said, the underprivileged mid-level energy sector is teeming with stocks with yields in fat. But you have to be selective, which is why your short, high-yielding list should start with this trio of top names in the industry.
1. Heavy in oil
Magellan Midstream Partners (NYSE: MMP) is a main limited partnership (MLP) which operates in the petroleum (34% of operating margin) and refined products (64%) areas. About 85% of its turnover is based on fees, so it is largely paid for the use of its assets; the basic price of the products it helps to transport is much lower. The current payout yield is 8.8%, which is near the high end of its historical range, suggesting that units are cheap today.
The problem is that oil and the products it is processed into is being out of favor due to the carbon footprint of fuel, which could limit demand for Magellan’s services and stunt its long-term growth prospects. These are very real considerations; however, oil will likely remain a key global energy source for years to come. And while transportation fuel, which is likely to be affected by the clean transition sooner than other regions, is a big part of Magellan’s history, vehicles are expensive assets with a lifespan of 10 years (or more). This suggests that Magellan’s business will remain vital for many years to come even as the world goes green. And the MLP has a long history of being fiscally prudent, with an industry low-end financial debt-to-EBITDA ratio. So there really is no reason to be overly concerned about its ability to survive the current headwinds. That said, its coverage rate in 2021 will likely drop to around 1.1 times, which isn’t great, but management remains committed to maintaining its distribution throughout the year. For those with a bit of a risk tolerance, this is a solid, high-yielding name to consider while striving to overcome the oil industry malaise.
2. More natural gas
The next step is the middle industry Enterprise Product Partners (NYSE: EPD), which is also structured as an MLP. It has a massive collection of largely paid-for pipeline, storage, processing and transportation assets that spans all of North America. In addition, the products circulating in its network are just as varied, but with a more marked emphasis on natural gas (around 60% of the segment’s gross operating margin). This fuel should help the world move away from dirtier carbon fuels like coal. The company’s historically high payout yield of 7.7% is backed by 25 years of annual payout increases (if you include the hike achieved in early 2021), making it a dividend aristocrat.
Like Magellan, Enterprise has a long history of prudent operation, with a financial debt to EBITDA ratio down to its peer group. The payout here, however, is much safer, with a 1.6x coverage ratio in 2020. It’s a solid option for more conservative high yield investors.
3. Similar but different
The last name on this list Kinder Morgan (NYSE: KMI), which is very similar to Enterprise in scale and scope. However, Kinder is structured like a regular business, so there are none of the MLP tax issues to consider. There are two caveats here, however. First, the mid-sector giant has improved its balance sheet in recent years, but its financial debt-to-EBITDA ratio of around 5.3 times is still near the industry high end. At this point, the issue of leverage is no longer as worrisome as it once was, but truly conservative investors may want to keep an eye on the issue nonetheless.
Second, Kinder Morgan cut its dividend by 75% in 2016 just months after telling investors to expect a dividend increase. To be fair, it was the right choice for the company (which has invested in growth projects), but there is a trust issue here that should not be overlooked even if the dividend increases again. That said, in the first quarter of 2021, Kinder Morgan hedged its distribution 1.8 times. The dividend therefore seems very secure at the moment even if the industry is facing headwinds. In fact, the company decided to increase the payout by around 3%, rewarding investors for staying in these tough times. If you don’t want the complexity of an MLP, Kinder Morgan is a good candidate even though its 6.2% return is a bit lower than the two names above.
High yields in a low yield world
No investment is perfect, so dividend-oriented investors looking for high yields should be prepared to make concessions today given the low yield in the market. However, if you can manage owning well-run businesses in a disadvantaged niche like the mid-level energy sector, you can certainly find attractive return options. Magellan bears the greatest risk here because of its ties to the oil industry. Enterprise Products places more emphasis on natural gas. And Kinder Morgan offers a chance to own a high yielding middle stock without the headache of the MLP structure. All three are worth a close look, as being on the sidelines of Wall Street has left them to offer generous returns.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.