Investors looking for high-yield dividend stocks often find great opportunities in the midstream energy sector. Many of these companies operate as master limited partnerships (MLPs), which provide significant tax advantages while passing substantial earnings to their unitholders. By design, MLPs do not pay corporate income taxes, allowing them to distribute the majority of their profits as distributions to investors. This structure often results in generous payouts, making them attractive investment vehicles for income-focused investors.
Understanding MLPs and Their Benefits
What Are Master Limited Partnerships (MLPs)?
MLPs are publicly traded entities that operate primarily in the energy sector, focusing on transportation, storage, and processing of natural resources like oil and natural gas. Unlike traditional corporations, MLPs distribute most of their cash flow to investors in the form of distributions, which resemble dividends but come with unique tax benefits.
Tax Advantages of MLPs
One of the primary advantages of MLPs is their tax treatment. A large portion of the distributions paid by MLPs is considered a return of capital, which is tax-deferred until the units are sold. This reduces the investor's cost basis and provides a tax-efficient income stream, albeit with some additional paperwork during tax season.
The Evolution of the Midstream Sector
Over the past decade, the midstream sector has undergone significant structural changes. Historically, MLPs were structured with a general partner (GP) and limited partners (LPs), where GPs benefited disproportionately due to incentive distribution rights (IDRs). These IDRs allowed GPs to receive a growing share of incremental distributions, making capital allocation less favorable for LPs.
The Shift Away from IDRs
Most MLPs have now eliminated IDRs and transitioned to a more investor-friendly model. This shift has improved financial stability, reduced leverage, and enhanced free cash flow generation. Surprisingly, despite these positive developments, many MLPs currently trade at historically low valuations, presenting a compelling buying opportunity.
Why Are Midstream Stocks Undervalued?
Between 2011 and 2016, MLPs traded at an average enterprise-value-to-EBITDA (EV/EBITDA) multiple of 13.7. Today, even with improved fundamentals, they trade at significantly lower multiples. This discrepancy provides investors with an opportunity to buy quality assets at a discount.
Additionally, increasing power demand from artificial intelligence (AI) and data centers is driving a surge in natural gas consumption. MLPs with extensive pipeline networks are well-positioned to benefit from this trend, making them attractive long-term investments.
Top Midstream MLPs for High-Yield Dividends
Given the attractive valuations in the sector, two MLPs stand out as compelling investment opportunities: Energy Transfer (NYSE: ET) and Enterprise Products Partners (NYSE: EPD). Both companies have strong financials, high yields, and significant growth potential.
Energy Transfer (NYSE: ET)
Company Overview
Energy Transfer owns one of the most extensive and integrated midstream asset portfolios in the United States. The company’s infrastructure spans pipelines, storage facilities, and processing plants, making it a key player in the energy supply chain.
Attractive Valuation & Yield
Energy Transfer trades at a forward EV/EBITDA multiple of 8.5, well below historical averages.
The company offers a forward yield of 6.4%, making it an appealing choice for income investors.
Management expects 3% to 5% annual distribution growth, ensuring consistent income increases.
Strong Coverage and Free Cash Flow
In the last quarter, Energy Transfer’s distribution coverage ratio was 1.8 times, indicating strong financial health.
The company generated over $165 million in free cash flow after distributions, demonstrating sustainability.
Growth Prospects
Energy Transfer is uniquely positioned to benefit from increasing natural gas demand, particularly in the Permian Basin. The company’s infrastructure provides access to some of the lowest-cost natural gas in the U.S., which is crucial for powering data centers.
Key growth projects include:
A $2.7 billion Permian gas takeaway project designed to transport natural gas to key demand centers.
Expansion plans aimed at connecting over 45 power plants and 40 data centers to its pipeline network.
With a combination of strong cash flows, an attractive valuation, and robust growth potential, Energy Transfer remains one of the best MLPs in the market.
Enterprise Products Partners (NYSE: EPD)
Company Overview
Enterprise Products Partners has long been recognized as one of the most financially disciplined MLPs. Unlike many of its peers, Enterprise eliminated its IDRs early on, ensuring a fairer structure for unitholders.
Consistent Distribution Growth
Enterprise Products Partners has increased its distribution for 26 consecutive years through various economic cycles.
The stock currently yields 6.4%, providing stable income for investors.
Attractive Valuation and Balance Sheet Strength
The company trades at an EV/EBITDA multiple of 10, making it undervalued compared to historical levels.
Enterprise has maintained a conservative leverage profile, reducing financial risk and ensuring steady cash flows.
Growth Opportunities
Enterprise is ramping up capital expenditures in response to rising natural gas demand. After scaling back investments post-pandemic, the company is increasing growth capex to $3.5 billion to $4 billion in 2024.
Key areas of expansion include:
Strengthening infrastructure in Texas, particularly around Dallas and San Antonio, where data center investments are booming.
Leveraging its extensive pipeline network to support increasing power demand from AI-driven industries.
With a strong history of financial discipline and a favorable position in high-growth markets, Enterprise Products Partners offers both stability and upside potential.
Conclusion: A Golden Opportunity in Midstream Energy
For investors seeking high-yield dividend stocks, the midstream energy sector presents a compelling opportunity. Many MLPs, including Energy Transfer and Enterprise Products Partners, trade at attractive valuations despite their improved financial strength and growth prospects.
Key reasons to consider investing in MLPs:
High Yields – Most MLPs offer above-average distribution yields, providing strong income potential.
Tax Benefits – The tax-deferred nature of MLP distributions enhances after-tax returns.
Undervalued Stocks – Current valuations are significantly lower than historical averages.
Growth Potential – Increasing energy demand, particularly from AI and data centers, creates strong tailwinds.
While MLPs require additional tax reporting (via K-1 forms), the combination of high yields, financial stability, and long-term growth prospects makes them a worthwhile consideration for income-focused investors. As the midstream sector continues to evolve, those willing to capitalize on current undervaluations stand to reap substantial rewards in the years ahead.