Better Dividend Stock: United Parcel Service vs. Enterprise Products Partners

If you are a dividend lover, you'll probably find the 6.5% yield from United Parcel Service (NYSE: UPS) attractive. You'll also likely appreciate the 6.8% yield on offer from Enterprise Products Partners (NYSE: EPD). However, investors must always balance risk and reward. From an income investor's perspective, the risk-reward balance between these two investments should produce a clear winner.

What does UPS do?

United Parcel Service, which is normally just called UPS, is a package delivery service. There was a temporary spike in demand for package delivery during the coronavirus pandemic, as people were forced to shop from home. Demand returned to more normal levels when the world reopened, leading investors to dump UPS stock.

Image source: Getty Images.

At that point, UPS decided to double down on a business overhaul. Essentially, management is trying to streamline its operations while also focusing on its most profitable business lines. The plan is solid, and UPS is likely to come out the other side of this turnaround effort a better-positioned company.

The stock price decline, largely driven by the inherent uncertainty surrounding a major business overhaul, has pushed the dividend yield up to 6.5%. That said, there's a not-so-subtle problem here. The dividend payout ratio is currently above 100%. That doesn't mean that a dividend cut is in the cards, since dividends are paid out of cash flow and not earnings.

Still, given the business reset taking shape at UPS, it wouldn't be surprising to see the board of directors choose to reset the dividend as well. All in, uncertainty is high for dividend investors when it comes to UPS.

What does Enterprise Products Partners do?

Enterprise Products Partners operates a midstream energy business. That means it owns energy infrastructure assets, such as pipelines, and charges customers fees to move their commodities through its system. The price of the oil and natural gas being moved is less important than the volume of the commodities that are moved. Given the importance of energy to the world, volume tends to remain robust regardless of the price of oil.

While the energy sector tends to be volatile, Enterprise operates in the most consistent segment of the industry. That's highlighted by a 27-year-long streak of annual distribution increases. That's basically as long as Enterprise has been a public entity, so reliable distribution growth is a core focus of the business.

There's nothing particularly exciting happening at Enterprise today. It is just business as usual. That said, the distribution yield is 6.8%. That's partly related to the use of the master limited partnership (MLP) structure, which is designed to pass income on to unitholders in a tax advantaged fashion (the drawback is that there is more work to do come April 15, including dealing with a K-1 form). The midstream space is also known for its large yields, so even companies that aren't MLPs often pay high dividends.

In other words, Enterprise's yield isn't at all shocking or unusual. Moreover, the company's distributable cash flow covers the distribution by a very robust 1.7x. Add in an investment-grade-rated balance sheet, and the risk of a distribution cut seems remote. It is far more likely that investors will benefit from further distribution increases in the years ahead.

Dividend investors have an easy choice

UPS isn't a bad investment, but it may not be the best choice for dividend-focused investors. A high payout ratio coupled with a major business overhaul suggests that there is more than a remote possibility that the dividend gets reset. There's material upside potential in the stock if the turnaround effort works out as planned, but turnaround investing is very different from dividend investing.

If what you are looking for is a reliable income investment, higher-yielding Enterprise Products Partners is likely to be a better choice. It remains as boring as it has always been, suggesting that continued slow-and-steady distribution growth is the most likely outcome investors can expect. If you are trying to maximize the income your portfolio generates, that should be highly attractive to you.

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