One of the best places to look when looking for high dividend stocks is in the midstream energy space. Many of these companies are structured Master Limited Partnerships (MLPs); They pass their profits on to unit owners and as such pay no corporate tax.
As a result, most of them pay very generous distributions, which are similar to dividends, but most of the payment is considered a return of capital. This portion is tax-deferred until the stock is sold and reduces the owner’s cost basis. This is a great benefit, although it does add some paperwork tax time.
The midstream sector as a whole has undergone many changes over the past decade. In the past, firms had a general partner (GP) and limited partner (LP) structure, which was ultimately more beneficial to the GP. The way it works is that GPs own what are called Incentive Distribution Rights (IDRs) and the LP pays a percentage of the distribution to the GP when they hit certain points.
This became very beneficial to the GP because once the MLP reached the 50/50 maximum distribution, the GP would receive half of the incremental distribution fee. For example, if a company increases its distribution by $0.02 per unit and that is $10 million (500 million units outstanding times $0.02), it must also send an additional $10 million to the GP under the IDR Agreement. This structure encouraged LPs to fund growth by issuing more equity, because the more units an LP owned, the higher the dollar payout.
Generally, this structure has been eliminated, and MLPs are generally in better financial shape, holding less leverage and able to grow their business with free cash flow. However, stocks are trading at a surprisingly low discount today, compared to where they traded in the old, inefficient model. Between 2011 and 2016, MLPs traded at an average of 13.7%. Corporate Value –to-EBITDA (earnings before interest, taxes, depreciation and amortization), the most common way to value these stocks.
Today, companies in the sector are trading at low valuations despite the industry as a whole doing better. This — along with the increased demand for artificial intelligence (AI) hardware in data centers — creates a good buying opportunity. Let’s take a look at two of the best MLPs to buy now.
Although it has some great properties with a large integrated system in the midstream space Power transmission(NYSE: ET ) It is one of the cheapest MLPs in the space, trading at a forward EV/EBITDA multiple of 8.5. It currently has a yield of 6.4% and expects to grow its distribution from 3% to 5% annually.
The spread is well covered, with a coverage ratio of 1.8 times based on cash flow divided by the previous quarter (cash flow minus capital expenditures for maintenance). And after paying distributions, it generated more than $165 million in free cash flow.
Energy Transition also has some of the best growth opportunities in the midstream space. This stems in part from its strong presence in the Permian Basin, which gives it access to the cheapest natural gas in the country. The Permian has been tapped primarily for oil, and there have long been capacity constraints for transporting the associated natural gas from the basin. This results in a much cheaper regional cost and makes Texas an ideal location for building data centers.
Energy Transmission also owns pipeline infrastructure to transport natural gas from the Waha Hub to various locations in West Texas. As a result, it said last quarter that it has seen inbound inquiries to connect around 45 power stations in 11 states to the pipeline system and more than 40 planned data centers in 10 states.
The company also announced a $2.7 billion Permian gas extraction project that it says will support data center growth in Texas.
Overall, Energy Transfer combines cheap stock with strong and well-covered distribution trading at historically attractive valuations.
Even in the old MLP model era, Enterprise product partners(NYSE: EPD ) It has always been one of the most shareholder-friendly companies in the MLP space. In the year In 2002, it removed 50% of IDRs in favor of a higher dividend of 25% and then eliminated them entirely and dismantled the structure in 2011. The company has always taken a more conservative approach and maintains strong balance sheets.
This has allowed the company to grow its distribution for 26 consecutive years through various economic and energy cycles. The stock currently yields 6.4% and trades at an EV/EBITDA multiple of 10.
The company is currently ramping up its growth considering the opportunities it is seeing. After increasing its growth capital to $1.6 billion in 2022 following the pandemic, it will spend $3.5 billion to $4 billion in 2024. Path for strong EBITDA increases in coming years.
Enterprise Products Partners is well-positioned to benefit from the growing demand for energy related to AI and data centers in Texas, particularly around the cities of Dallas and San Antonio. The company says AI-powered energy demand is one of the most promising signs it has seen in the natural gas sector in a long time, and it has some great assets to take advantage of this trend.
In general, enterprise product partners have more opportunities when trading itself with a consistent model and attractive pricing.
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Jeffrey Seiler He has positions in energy transmission and enterprise product partners. Motley Fool Recommends Enterprise Products Partners. The Motley Fool has Disclosure Policy.