Should You Buy Energy Transfer or This High-Yield Alternative?

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.

ET Dividend Per Share (Quarterly) data by YCharts

In 2020, Enterprise Products Partners increased its quarterly distribution to $0.445 per unit, up from $0.4425 in the final quarter of 2019. To be fair, Enterprise's distribution was raised on a quarterly basis up until 2020 and that was rolled back to yearly during the pandemic. Still, the bigger story is that Enterprise Products Partners continued to reward investors with regular increases even in the face of extreme uncertainty.

Reliability is the issue

Energy Transfer has basically set a precedent. If the energy market hits a rough patch, it may resort to cutting its distribution. That might be the right thing for the MLP, but it will be a hard pill for dividend investors to swallow. Enterprise has also set a precedent. It will keep raising its distribution in both good times and bad ones. In fact, its annual streak of increases is up to 26 years. So, not only did it increase its distribution during the pandemic, but it also increased it during the Great Recession.

If you are the type of dividend investor who cares about income consistency, which is likely to include most dividend investors, you'll probably decide that Enterprise is a better choice than Energy Transfer. The fact that Enterprise has a lower yield won't likely be a big problem for you.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.