When you look at a high-yield investment opportunity you need to look at the business behind the yield. After all, a yield is only as reliable as the business that supports it. If you have honed in on Energy Transfer (ET 1.44%) and its 6.7% distribution yield, you might want to instead consider Enterprise Products Partners (EPD 1.64%) and its slightly lower 6.4% yield. Here's why.
Energy Transfer lets unitholders down
There are two specific examples that should lead income investors to avoid Energy Transfer. The first happened in 2020, when the energy sector was in a deep downturn. That downturn was understandable, given that the coronavirus pandemic was raging and economic activity around the world had come to a virtual halt. So, in some ways, it makes sense that, out of caution, Energy Transfer cut its distribution from $1.22 per unit per quarter to $0.61, a 50% reduction. However, if you were a unitholder expecting to live off of the income your portfolio generated, a cut that large would have left a huge hole in your budget.
The next problem dates back to the 2016 energy industry downturn. That was when Energy Transfer agreed to buy its pipeline peer Williams Companies (WMB 2.86%) but then, because of the broader industry weakness at the time, backed out of the deal. An odd twist was Energy Transfer's decision to sell convertible securities, a large portion of which went to the then-CEO. Energy Transfer warned that completing the merger with Williams would risk a dividend cut, but the convertible securities would have, effectively, protected the CEO from being adversely affected by that cut. In the end, the deal was scuttled and Energy Transfer ended up having to pay nearly $500 million to Williams because of its actions, money that really comes out of unitholders' pockets. It was a complicated affair, but it is pretty clear that when the chips are down in the energy sector, Energy Transfer unitholders have some cause to wonder if they are going to be top of mind.
Enterprise Products Partners keeps growing its distribution
Although Enterprise Products Partners' yield is slightly lower than that of Energy Transfer, Enterprise has increased its distribution year in and year out for 26 consecutive years. That includes years like 2020 and 2016 when investors in Energy Transfer either experienced a cut or had to be concerned about the decisions being made by management and the board on that front.
That consistent distribution growth is probably enough to make Enterprise Products Partners a buy over Energy Transfer. But there's more to like about Enterprise. For example, the North American pipeline giant has an investment grade-rated balance sheet. And its distributable cash flow covers its distribution by 1.7 times. There is a lot of room for adversity before a distribution cut would be on the table here.
Also, the lofty distribution coverage was a management choice. It used to be lower, averaging around 1.2 times. However, Enterprise wanted to shift its business model so that it was able to self-fund more of its capital investment projects. This means that it doesn't need to issue units as often, a move that could potentially dilute unitholders, to pay for growth spending. Acquisitions are the most likely time when units might be issued, but the cash flows from acquisitions start right away (unlike ground-up development, where assets have to be built before cash flows are generated). So dilution isn't as big an issue. This shift took a few years, but in the end, it is a unitholder-friendly change that speaks to management's commitment to the actual owners of Enterprise Products Partners.
Go with the midstream giant that has had your back
From a big-picture perspective, there are some material similarities between midstream giants Energy Transfer and Enterprise Products Partners. But when you examine the comparison a little more deeply, some important differences start to show up. Most notably, Enterprise Products Partners has been a much more reliable income investment. If you like to sleep well at night, you'll likely want to go with Enterprise Products Partners over Energy Transfer even though it has a slightly lower yield.