What Is the Best High-Yield MLP for Income Investors?

Income investors are naturally attracted to Master Limited Partnerships, or MLPs. These are companies that are structured differently from traditional corporations, typically in the oil and gas industry.

The appeal of MLPs is that they pay high dividend yields of 5% or more in many cases.

Enterprise Products Partners L.P.  (EPD) and Energy Transfer LP (ET) are two of the largest MLPs, and both pay high distributions. Enterprise Products and Energy Transfer have yields of 5.9% and 7.8%, respectively, which makes them very attractive for income investors.

Of course, investors should care just as much -- or more -- about sustainability of a distribution rather than simply the yield itself. This includes an analysis of a company's growth prospects and the health of its balance sheet. From this perspective, while both companies are attractive for income, one comes out on top.

Pumping Oil, Gas - and Cash Flow

Enterprise Products Partners is the largest energy MLP based on market capitalization. It is a midstream MLP, with services including storage and transportation of oil and gas. Enterprise Products Partners' assets include approximately 50,000 miles of pipelines, 260 million barrels of storage capacity for NGL (Natural Gas Liquids), crude oil, and other refined products, and 14 billion cubic feet of natural gas storage capacity.

In late January (1/31/19) Enterprise Products reported strong financial results for 2018. In 2018, liquid pipeline volumes increased 9%, natural gas pipeline volumes increased 12%, marine terminal volumes increased 12%, NGL fractionation volumes increased 14%, and propylene plant production volumes increased 23%. Distributable cash flow increased 29% for the fourth quarter and 33% for the full year. Last year was a highly successful one for Enterprise Products. The partnership established 23 operational and financial records in 2018.

Energy Transfer is also a midstream oil and gas MLP. It is the second-largest midstream MLP based on market capitalization (behind Enterprise Products Partners) and the largest based on enterprise value. Energy Transfer has a gathering capacity of 12.8 million Btu/day of gas and a transportation capacity of 22 million Btu/day of natural gas and 4.3 million barrels per day of oil. Energy Transfer also owns the Lake Charles LNG Company, as well as a stake in publicly traded Sunoco LP (SUN) and USA Compression Partners (USAC) .

On February 20, 2019 Energy Transfer reported Q4 and full-year results for the period ending Dec. 31, 2018. For the quarter net income attributable to partners was $617 million or $0.26 per unit compared to $0.22 in the prior-year period. Net income per unit for the year came in at $1.15 against $0.83 in the prior year. Distributable cash flow for the year totaled $5.4 billion compared to $4.1 billion in 2017, however, keep in mind that this is just the second quarterly report of Energy Transfer reporting as a combined entity.

Cash Flow Fuels Growth Investment

For both companies, future growth will come from new projects. For example, Enterprise Products has started construction of the Mentone cryogenic natural gas processing plant in Texas, which will have the capacity to process 300 million cubic feet per day of natural gas and extract more than 40,000 barrels per day of natural gas liquids. The facility is expected to begin service in the first quarter of 2020.

Also expected to begin service in 2020 is the Shin Oak NGL Pipeline, which will have total capacity of 600,000 barrels per day. Exports are another growth catalyst. Demand for liquefied petroleum gas and liquefied natural gas, or LPG and LNG, respectively, is growing at a high rate across the world, particularly in Asia. Enterprise Products' total crude oil, NGL, petrochemical, and refined products exports currently exceed 1.6 million barrels per day.

Energy Transfer has an attractive lineup of new projects which will fuel the company's growth. For example, ET announced it will construct a seventh NGL fractionation facility at Mont Belvieu, Texas, with 150,000 barrels per day of capacity. Fractionator VII is scheduled to be operational in the first quarter of 2020 and is fully subscribed by multiple long-term contracts.

Balance Sheet Analysis

It is very important for investors to analyze MLP balance sheets. If investors learned anything from the 2014-2016 oil and gas industry downturn, high yields can vanish if a company has to cut its distribution. Many MLPs cut or suspended their distributions during the 2014-2016 downturn, because they had highly leveraged balance sheets with far too much debt. As a result, it is important to analyze a company's credit rating and leverage ratios, to confirm that there is enough cash flow to service the debt as well as pay distributions.

From this perspective, Enterprise Products has a major advantage. It is arguably one of, if not the safest MLPs. The partnership sports an investment-grade credit rating of BBB+ from Standard & Poor's and Baa1 from Moody's, higher than the majority of MLPs. Its distribution safety is also very strong. The partnership reported a distribution coverage ratio of 1.5x in 2018. The company ended 2018 with a healthy leverage ratio of 3.5x.

Energy Transfer has been actively paying down debt. Prior to the merger, ET was able to reduce its debt-to-adjusted-EBITDA ratio down from 5.5x in the first quarter of 2017 to 4.1x in the second quarter of 2018. This is still a bit high, as a leverage ratio above 4.0x can be problematic. Separately, Moody's revised the combined entity's credit rating to Baa3 investment grade (stable) and the partnership has told investors that it anticipates funding the majority of its growth capex with retained cash flow moving forward.

Importantly, Energy Transfer reported a distribution coverage ratio of 1.9x for the fourth quarter, and 1.74x for 2018. This was a notable improvement from the previous year's fourth-quarter and full-year coverage ratios of 1.66x and 1.54x, respectively. ET believes that distribution coverage moving forward will be in the ~1.7x to ~1.9x range. This indicates the distribution is sustainable, but high debt remains a concern. It has an investment-grade credit rating, but not as high as Enterprise Products.

Final Thoughts

Both Enterprise Products and Energy Transfer are high-quality MLPs that have strong business models and premier assets. And, both pay very high yields. Each company has a positive growth outlook that should allow them to sustain their distributions.

However, Enterprise Products has a higher credit rating and a longer history of distribution growth. It has increased its distribution for 59 consecutive quarters in a row. This streak encompasses both the Great Recession and the 2014-2016 oil and gas downturn.

Energy Transfer has a higher yield, which makes it slightly more attractive for current income. But Enterprise Products is the better choice for risk-averse investors.