Utility Stocks are Great – But These Energy Stocks are Even Better

Energy Investing

A recent article highlighted the differences between the different income-focused investment sectors. Investors often see energy midstream and utilities as similar infrastructure-type investments.

Both pay high yields and tend to be pretty safe bets.

But significant differences exist, so let’s see where best to put your money…

Utility stocks, real estate investment trusts (REITs), and energy midstream companies/MLPs attract investors due to attractive yields and growing dividends. This chart comes from a recent article on the VettaFi ETF Trends website.

The article noted that year-to-date through August 24, utilities had posted a negative 9.1% total return. Over the same period, the Alerian MLP Infrastructure Index (AMZI) has gained 15.7%, and the Alerian MLP Infrastructure Index (AMEI) is up 8.2%. The performance difference stems from how the two sectors are managed for growth.

Utilities primarily fund their growth projects with debt. Rising interest rates over the last year and a half have significantly increased the cost of capital for utility companies. Investors fear utilities will be unable to match historic dividend growth rates, or may even stop growing their payouts altogether.

Before the 2014-2016 crash of energy prices and energy sector stocks, energy midstream used a similar business model, organized as master limited partnerships (MLPs). Growth projects were funded with a combination of new equity and debt. Often, 100% or more of free cash flow was paid out as distributions to investors. Growth was the goal, by developing new energy infrastructure projects and using the resulting revenue to fuel distribution growth.

The energy sector crash blew up the MLP business model. The companies could no longer grow, and debt servicing ate up larger and larger portions of revenue. The entire sector was forced to restructure its business, and went through massive consolidation. In October 2014, energy midstream included 94 MLPs and corporations. After some recently announced acquisitions, the sector will be down to 21 companies, with only 10 of those organized as midstream.

The shift away from relying on debt to fund new infrastructure projects is of greater importance. MLPs and midstream corporations now support growth out of retained cash flow. They have significantly reduced the dividend payout ratios. The companies in the sector have also paid down debt. Before the crash, it was common to see debt-to-EBITDA ratios of five to six times. Now, less than three times is about the standard.

As a result of the near-decade of restructuring, midstream companies generate tremendous free cash flow. They can pay generous and growing dividends while still funding growth projects or “bolt-on” acquisitions.

I recommend the InfraCap MLP ETF (AMZA) to my Dividend Hunter subscribers. The ETF yields 8%, pays monthly dividends, and the dividend should grow by high single digits each year. To see the full portfolio of high-yield investments I recommend, click below to join today.