The S&P 500's dividend yield is a rather pedestrian 1.4% these days. At that rate, you could earn about $14 of annual dividend income for every $1,000 invested in an S&P 500 index fund.
Many stocks offer higher yields -- some considerably more. One of the more compelling options for yield-seeking investors is master limited partnerships (MLPs). While MLPs can complicate your taxes (they send K-1s instead of 1099-DIVs), the extra income can be well worth it. Top MLPs Energy Transfer(NYSE: ET) and MPLX(NYSE: MPLX) currently yield over 8%. At that rate, a $1,000 investment would generate over $80 in annual income.
Visible income growth
Energy Transfer offers an 8.3%-yielding distribution. That monster payout is very bankable. The midstream giant generates stable cash flow of roughly $7.5 billion annually because fees supply about 90% of its earnings. Meanwhile, the company pays out a conservative portion of its steady cash flow (around 50%, or $4 billion). That gives it a huge cushion while enabling it to retain money to fund its organic expansion program ($2 billion-$3 billion annually) with room to spare. It uses its excess free cash (about $500 million to $1.5 billion per year) to maintain a strong balance sheet and opportunistically repurchase its units.
The company also has a very solid balance sheet. Energy Transfer expects its leverage ratio to be in the lower half of its 4.0x-4.5x target range this year. That gives it additional financial flexibility to make acquisitions. Energy Transfer is a consolidator in the midstream sector. It made two deals last year, including buying fellow MLP Crestwood Equity Partners for $7.1 billion. Those acquisitions enhanced its operations while growing its distributable cash flow.
Energy Transfer's growth-focused investments will increase its sources of steady cash, which is why management believes it can boost its already sizable distribution. It aims to lift that payout by 3% to 5% per year by slightly raising its distribution payment each quarter. That makes it an excellent source of steadily rising passive income.
A potentially high-octane income stream
MPLX currently pays an 8.4%-yielding distribution. That big-time payout is also on a very firm foundation. The MLP generates predictable cash flow backed primarily by long-term contracts with quality customers, including its parent company, refining giant Marathon Petroleum.
Last year, MPLX produced $5.4 billion in net cash provided by operating activities. That covered its distribution payments ($3.3 billion) and capital expenses ($1.3 billion) with over $800 million to spare. It used some of that excess free cash to acquire the remaining 40% interest in a gathering and processing (G&P) joint venture from its partner for $270 million.
The remaining excess free cash further strengthened the MLP's fortress-like balance sheet. MPLX ended last year with $1 billion in cash and a low 3.3x leverage ratio, well below the 4.0x its stable cash flows could support. That gives the company significant financial flexibility. It has the capacity to make opportunistic acquisitions and unit repurchases.
MPLX is currently investing money to expand its logistics and storage and G&P segments. It has a couple of pipeline projects and a few more processing plants under construction that should enter service through next year. These projects and its recent acquisition should help grow its distributable cash flow, which rose by more than 7% last year.
That growing cash flow should allow MPLX to continue boosting its payout. It has given investors 10% raises in each of the past two years. Given its increasing cash flows, strong balance sheet, and robust coverage ratio (1.6x), the MLP could continue giving its investors sizable raises.
Premium income streams
MLPs can be great passive income producers. Energy Transfer and MPLX offer distributions yielding more than 8% that they will likely continue increasing. That makes them ideal investment options this March for those seeking big-time yields.
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Matt DiLallo has positions in Energy Transfer. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
