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Energy Transfer (NYSE: ET) is offering a very attractive yield of about 7.6% today. The broader market's yield is a miserly 1.3%, while the average energy stock's yield is around 3%. But dividend investors shouldn't jump on Energy Transfer just yet. This alternative, with a 6.9% yield, might end up being a better pick. Here's why.
What does Energy Transfer do?
From a big-picture perspective, Energy Transfer is a midstream business. That means it owns the energy infrastructure, like pipelines and storage assets, that help to move oil and natural gas around the world. It basically sits between the upstream (drillers) and the downstream (chemicals and refiners) and charges fees for the use of its vital energy assets. That model is similar to a toll on a bridge.
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The good news is that the energy industry would come to a screeching halt if the midstream sector were to disappear. It doesn't really matter if oil prices are high or low -- it has to be moved, and that is what Energy Transfer makes happen. Cash flows tend to be fairly reliable through the cycle for midstream businesses.
This model is, basically, the same one used by every midstream business, so Energy Transfer is not unique in this regard. For example, peer Enterprise Products Partners (NYSE: EPD) does roughly the same thing, but it only offers a yield of "just" 6.9%. And that lower yield may actually turn out to be a better choice for most investors.
The problem with Energy Transfer
The big concern when it comes to Energy Transfer boils down to reliability. The master limited partnership's (MLP's) distribution has been heading steadily higher since 2021 after being cut in half in 2020. No explanation was provided when the dividend cut was announced. When the next earnings release came out, the only comment was, "ET expects to use the excess cash resulting from this distribution decrease to reduce debt."
There's nothing wrong with strengthening the balance sheet by paying down debt in an uncertain environment. The year 2020 was a very uncertain time, thanks to the COVID-19 pandemic. In fact, West Texas Intermediate (WTI) crude, a key U.S. oil benchmark, actually fell below zero at one point, highlighting the dislocation caused by the health crisis. However, investors trying to live off of the income their portfolios generate would have been hit hard by what was a massive 50% reduction in Energy Transfer's distribution.
