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Oil prices are highly volatile. That’s certainly been the case this year. Crude prices started at around $75 a barrel before surging to $120 a barrel after Russia invaded Ukraine. They’ve cooled off considerably in recent months, slumping below $90 a barrel on fears the global economy will slow down and crimp demand.
While that volatility is an issue for companies that produce oil, it isn’t a problem for pipeline companies. Many make consistent money no matter the market condition. That enables them to generate steady cash flow to pay big-time dividends. Two great pipeline stocks for those seeking to turn some idle cash into an income-producing investment are Enbridge (ENB 0.86%) and Energy Transfer (ET -0.61%).
Enbridge currently has a 6.5% dividend yield. That’s several times above the roughly 1.5% dividend yield of an S&P 500 index fund. A $1,000 investment in Enbridge would generate $65 of annual dividend income, compared with $15 per year in the S&P 500.
That ultra-high-yielding payout is on a very sustainable foundation. Enbridge has a low-risk business model focused on pipelines and utilities. The company’s diversified energy infrastructure platform includes gas distribution, gas transmission, liquids pipelines, and renewable power assets. These businesses generate very steady cash flow backed by long-term contracts and government-regulated rate structures.
Enbridge pays out about 65% of its cash flow to support its big-time dividend. That enables the energy infrastructure giant to retain billions of dollars each year to help fund new investments. It currently has a multi-billion-dollar backlog of projects under construction that should help grow its cash flow per share by 5% to 7% per year through at least 2024. That growing cash flow should enable Enbridge to continue increasing its dividend, something it has done for the last 27 straight years.
Energy Transfer’s yield is up around 7.9% these days. This rate implies the master limited partnership (MLP) could produce nearly $80 of income each year.
However, it will likely pay its investors more than that in the future. The company has been steadily ratcheting up its cash distribution, aiming to return the payout to its former peak. Energy Transfer has already increased its payment by more than 50% this year. Its goal is to increase the distribution payment to $1.22 per unit each year, the rate it paid before reducing it in 2020 to focus on debt reduction. That implies more than 30% upside potential for the payment.
Energy Transfer can easily afford to deliver on that promise. The MLP covered its payout by 2.65 times in the second quarter, enabling it to produce nearly $1.2 billion of excess cash after paying its distribution. That gave it the funds to cover its $825 million of growth-related spending with room to spare, enabling the company to continue paying down debt. Energy Transfer’s continued debt reduction has it closing in on its long-term leverage target. Once achieved, the MLP will have even more financial flexibility to boost the payout.
Meanwhile, there’s the potential that Energy Transfer’s payout could eventually exceed its former peak. The MLP is investing in several expansion projects that should grow its cash flow. It’s also working on a few potentially needle-moving investments to drive future growth. These projects should expand the company’s cash flow, potentially enabling it to continue increasing its payout in the future.
Pipeline companies can be great income producers. They generate relatively steady cash flow, giving them the funds to pay high-yielding dividends and invest in growing their operations. And that means they can turn a $1,000 investment into a sizable (and growing) income stream. That makes them great options for those seeking to make some investment income.
Matthew DiLallo has positions in Enbridge and Energy Transfer LP and has the following options: short October 2022 $8 puts on Energy Transfer LP. The Motley Fool has positions in and recommends Enbridge. The Motley Fool has a disclosure policy.
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