Should Investors Hold Off on Buying These 2 High-Yield Energy Stocks?

By Markets Fool.com

As most investors probably know by now, the price of oil collapsed last year. West Texas Intermediate fell from $100 per barrel at its 2014 peak to about half that, before recovering slightly. This crushed most oil and gas exploration and production companies, because those businesses are highly reliant on the price of oil.

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One industry that remained relatively unscathed from the oil crash was midstream operators. These companies operate pipelines and storage terminals that transport oil and gas. Similar to toll roads, midstream companies are not dependent on commodity prices, but rather volumes of oil and gas. This explains why midstream MLPs like Magellan Midstream Partners and Enterprise Products Partners fared better than most other oil and gas companies over the past year.

However, this insulation against volatile changes in commodity prices also means the midstream majors aren't providing investors with good buying opportunities. Magellan and Enterprise Products still hold lofty valuations that are near multi-year highs, which means investors may want to wait on the sidelines for a better entry point before jumping in.

Low yields, high valuations
Perhaps the best thing investors can say about the collapse in oil prices last year is that it created fantastic buying opportunities across the energy sector. Companies that saw their stock prices crushed at least gave prospective investors an attractive valuation and higher dividend yield. Unfortunately, investors hoping to get a decent buying opportunity in midstream MLPs are still waiting.

For example, Magellan Midstream and Enterprise Products both trade for approximately 18 times enterprise value to earnings before interest, taxes, depreciation, and amortization (EBITDA). This is very close to the five-year high for both. A side consequence of their expanding valuations over the past several years is that their distribution yields have fallen to multi-year lows. This is because share prices and yields are inversely related. At their recent prices, Magellan and Enterprise Products yield 3.4% and 4.2%, respectively, which are near their five-year lows. The following chart demonstrates the rising multiples and falling yields for these two midstream giants.

MMP Dividend Yield (TTM) Chart

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MMP Dividend Yield (TTM) data by YCharts

Midstream Master Limited Partnerships are highly valued by investors for their distributions. MLPs enjoy a favorable tax structure, and in exchange, they are required to distribute the vast majority of their cash flow to investors. This typically results in high yields that are beloved by income investors. Unfortunately, because of their rising valuations, Magellan and Enterprise Products sport distribution yields that are near multi-year lows.

Great businesses, but not-so-great prices
The problem with Magellan and Enterprise Products isn't that they are not high-quality businesses. In fact, both produced growth last year. Magellan grew distributable cash flow by 31% to $880 million, due largely to increased shipments on its Longhorn pipeline. Meanwhile, Enterprise Products grew distributable cash flow by 8% to $4.1 billion, again due to volume growth in its fee-based businesses.

Because of this growth, both Magellan and Enterprise Products have passed along significant distribution increases for several years. Magellan increased its distribution by 20% last year and targets 15% distribution growth this year, along with at least a 10% increase in 2016. For its part, Enterprise Products' distributions declared in 2014 were $1.45 per unit, a 5% increase compared to 2013.

This distribution growth is certainly impressive, but their unit prices have increased even faster than their distributions have risen in recent years. This has resulted in the companies' yields sitting near multi-year lows.

While Magellan and Enterprise Products are certainly great businesses, even excellent companies can be poor investments if their valuation is too high. Because of this, investors may want to wait on the sidelines before buying these two midstream giants.

The article Should Investors Hold Off on Buying These 2 High-Yield Energy Stocks? originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Enterprise Products Partners and Magellan Midstream Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.