These 3 Energy Dividend Stocks Are the Best of the Best

Investors are facing two big headwinds right now: High inflation and the nearly all-time high level of the S&P 500, which has led most stocks to offer lackluster dividend yields. An answer, however, is investing in master limited partnerships.

MLPs offer tax-advantaged income and return most of their cash flows to their shareholders. As a result, they offer distribution yields that are much higher than those of the vast majority of stocks.

In this article, we will analyze three high-quality MLPs which are offering exceptionally high yields right now:

Hook Up With Holly Energy Partners  

Holly Energy Partners (HEP) owns essentially all the pipeline network of crude oil and refined products as well as the terminal assets that support the refining and marketing business of HollyFrontier (HFC). Among others, this asset portfolio includes storage capacity of approximately 15 million barrels of refined products and 3,400 miles of pipelines of crude oil and refined products.

The earnings of Holly Energy Partners are closely linked to the total volume of crude oil and refined products transported and stored through its network. Consequently, the MLP could be expected to be vulnerable to the coronavirus crisis, just like most energy companies.

However, Holly Energy Partners has proved markedly resilient to the pandemic thanks to its defensive business model. Nearly all its revenues are fee-based and approximately 75% of its revenues are based on minimum-volume contracts. In other words, its customers have to pay minimum amounts to the company even if they transport and store much lower quantities than expected.

The merits of this business model have been clearly reflected in the results of Holly Energy Partners. The MLP grew its distributable cash flow per share by 4% in 2020 and by another 4% in 2021.

Moreover, Holly Energy Partners has an impressive distribution growth record. It raised its distribution for 58 consecutive quarters at a 7% average annual rate until 2020. As this period includes the Great Recession and the downturn caused by the collapse of the oil price from $100 in 2014 to $26 in 2016, the distribution growth streak of Holly Energy Partners is a testament to its robust business model.

Although Holly Energy Partners had sufficient cash flows to defend its distribution during the pandemic, it chose to cut its distribution by 48% in 2020 in a precautionary move, due to the uncertainty caused by the pandemic. However, the stock is still offering an exceptional 7.7% distribution yield.

More importantly, the MLP currently has a distribution coverage ratio of 1.8 and a healthy leverage ratio (net debt to EBITDA) of 4.0, which provide a wide margin of safety. Therefore, investors can lock in a 7.7% yield and rest assured that the distribution has a wide margin of safety.

Get Piped Into MPLX

MPLX (MPLX) is a diversified, large-cap MLP which was formed by Marathon Petroleum MPC in 2012. It owns and operates midstream energy infrastructure and logistics assets, and provides fuels distribution services. It operates in two segments: Logistics and Storage, which involves the transportation and storage of crude oil and refined products, and gathering and processing, which is related to natural gas and natural gas liquids (NGLs). Logistics and Storage generates approximately 65% of the total EBITDA of MPLX.

The business model of MPLX is very similar to that of Holly Energy Partners. MPLX receives fees that are proportional to the volumes transported and stored in its network. It also has long-term contracts with minimum-volume requirements, which secure a minimum amount of fees even if its customers transport and store lower volumes than initially agreed. Thanks to its defensive business model, MPLX has proved one of the most resilient oil companies to recessions, including the coronavirus crisis.

MPLX raised its distribution every quarter since its formation, until 2020. Due to the pandemic, MPLX froze its distribution for seven consecutive quarters. However, thanks to the ongoing recovery of the energy market, the MLP raised its distribution by 2.5% in the fourth quarter.

Moreover, the stock is currently offering an exceptionally high distribution yield of 8.9%. Given the strong distribution coverage ratio of 1.6, its healthy leverage ratio of 3.7 and its promising pipeline of growth projects, its distribution should be considered safe for the foreseeable future.

Head to Plains All American Pipeline

Plains All American Pipeline (PAA) is a midstream energy infrastructure provider. The MLP owns an extensive network of pipeline transportation, terminals, storage, and gathering assets in key producing basins of crude oil and natural gas liquids at major market hubs in the U.S. and Canada. On average, it handles more than 6 million barrels per day of crude oil and natural gas liquids through 18,370 miles of pipelines and gathering systems.

Plains All American Pipeline has many minimum volume contracts in place and thus it enjoys relatively stable revenues in its transportation segment. These contracts have an average remaining term of approximately 5 years. On the other hand, the performance of the supply and logistics segments of the company is highly sensitive to the underlying demand for oil and gas and hence it is much more volatile.

This is the key factor behind the performance record of Plains All American Pipeline, which is much more volatile than the performance record of Holly Energy Partners and MPLX. Plains All American Pipeline was severely hurt by the downturn of the energy sector in 2014-2016 and has not returned to its profitability levels of 2012-2014. Moreover, it has been greatly affected by the coronavirus crisis. Its distributable cash flow per share dipped by 23% in 2020 and by another 17% in 2021.

Due to its vulnerability to downturns, Plains All American Pipeline cut its distribution by 50% in 2020. On the bright side, the stock is still offering an attractive 6.9% distribution yield. Given the solid payout ratio of 38%, the distribution has a wide margin of safety, particularly given the ongoing recovery of the energy market from the pandemic.

It is also important to note that the stock is currently trading at only 5.4 times its distributable cash flow. This is a decade-low valuation level, which indicates that the stock is deeply undervalued right now. Overall, while Plains All American Pipeline is less resilient than the other two MLPs analyzed in this article, it is markedly attractive right now thanks to its generous distribution and its exceptionally cheap valuation level.

When a stock offers an abnormally high yield, it may signal that a dividend cut is just around the corner. Therefore, investors should perform their due diligence before purchasing a high-yield stock. With that said, the above three high-yield stocks are best-of-breed MLPs, which are offering exceptionally high distribution yields with a wide margin of safety. As a result, they are great candidates for the portfolios of income-oriented investors.

At the time of publication, Ciura had no position in any security mentioned.