With a yield of 11.3%, Energy Transfer Partners (NYSE: ETP) catches the eyes of income investors. However, with as much risk as it has reward, this master limited partnership (MLP) isn't the best option for those seeking a steady income stream. That's why dividend-seekers shouldn't bother with Energy Transfer but instead should consider buying Enterprise Products Partners (NYSE: EPD). While Enterprise has a lower current yield of 6%, that payout should keep growing while Energy Transfer's has a good chance of getting cut.
Drilling down into the numbers
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One of the reasons Energy Transfer Partners has such a sky-high yield is that the company's financials are in rough shape, especially compared with a top-tier MLP like Enterprise Products Partners:
As that chart shows, Energy Transfer's leverage ratio is well above that of Enterprise Products Partners, which makes financing growth projects more expensive. While Energy Transfer is working to whittle that number down, and recently completed another transaction that will reduce debt, its balance sheet remains an area of concern.
Another trouble spot is its coverage ratio, which is tighter than it looks. That's because Energy Transfer's parent, Energy Transfer Equity (NYSE: ETE), is currently providing it some support by giving up a portion of its incentive distribution rights. Without that help, Energy Transfer Partners would have distributed roughly $150 million more to investors than it brought in through the third quarter of last year. That's a concern, because Energy Transfer Equity's support will shrink significantly this year.
Getting safer versus an increasingly costly way of doing business
Enterprise Products Partners has better metrics than Energy Transfer because it has a much more conservative financing strategy. One aspect of this strategy is to retain a meaningful portion of its cash flow to help finance expansion projects. In fact, the company recently decided to slow the pace of its distribution growth rate, so it would retain more cash flow to fund growth. That plan puts the company on pace to internally finance the equity portion of a $2.5 billion annual capital investment program starting next year. It's an approach that should enhance the company's financial flexibility and has the potential to create "greater long-term value" for investors, according to CEO Jim Teague.
Contrast that with Energy Transfer's plan to continue distributing all its cash to investors. Because it will do that, the company will need to keep issuing more debt and equity to finance growth projects no matter the cost. To put this difference into perspective, Enterprise Products Partners' strategy would eliminate the need for selling more of its 6%-yielding equity to finance expansions, saving it from having to pay out that incremental cash to new investors for years to come. Energy Transfer, on the other hand, would need to issue equity at 11% to finance growth. On a $1.25 billion equity investment, that adds up to a difference of $200 million in additional annual cash distributions. That's money that won't go toward creating value for existing investors, such as a higher distribution, additional high-return expansion projects, or a repurchase program. It would put Energy Transfer at a disadvantage and could ultimately force the company to reduce its payout so it can internally finance at least a portion of its future growth projects.
Don't bother stretching for this yield
While it's tempting to want to buy Energy Transfer for its double-digit yield, that payout isn't worth the risk, since it's quite possible that the company could eventually reduce its distribution. That's why income-seekers should instead opt for the much safer payout Enterprise Products Partners offers. Not only should its distribution continue heading higher for years to come, but its strategy also has the potential to create more value for investors over the long run.
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