1,000 Units of Enterprise Products Partners Pay $2,240 a Year. Here’s What the Latest Earnings Say About Whether That’s a Safe Passive Income Stream.

If you own 1,000 units of Enterprise Products Partners (NYSE:EPD), you'd collect $560 each quarter, or $2,240 per year. That's at the master limited partnership's (MLP) current distribution rate of $0.56 per quarter ($2.24 annually), a 5.7% yield at its recent unit price. It's the kind of steady paycheck income investors want from a pipeline business.

It's easy to take this income for granted. The MLP's recent third-quarter report is a good time to ask a harder question: Does it generate enough cash to comfortably cover this payment? Here's a look at what the high-yield dividend stock's recent earnings tell us about the safety of its payout.

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How much cash covers the payout?

Enterprise measures its ability to pay distributions using distributable cash flow (DCF), which approximates the cash the business generates after covering the maintenance of its existing pipelines and plants. In the third quarter, DCF from normal operations was $2.3 billion, up 27% from a year ago. That covered its current distribution by 1.9 times, leaving $1.1 billion to spare. The pipeline company can use its retained cash to invest in growth, repurchase units, and retire debt.

That cushion has widened over the past year, even though Enterprise has continued to increase its distribution (2.8% growth over the last 12 months; it's its 28th straight year of raising the payout). A year ago, the MLP covered its payout by 1.5 times, allowing it to retain $635 million in cash.

Free cash flow adds a tougher test

I like to dig a little deeper than just distribution coverage. Pipeline companies invest heavily to expand. I want to see that a company is producing enough cash to cover its payout and at least half of its growth capital expenditures. That way it's not putting too much pressure on its balance sheet or issuing dilutive equity to fund its growth.

During the third quarter, the MLP's capital expenditures were around $1.1 billion. That was right in line with its excess cash flow after paying distributions, meaning it covered 100% of growth-related investment spending. That's a very strong result.

It enabled the MLP to maintain one of the strongest balance sheets in the sector (it's the only midstream energy infrastructure company with A-/A3 credit ratings). Enterprise ended the third quarter with a leverage ratio of 2.9x, at the lower end of its 2.75x-3.25x target range. That's allowing it to return additional cash to investors through its unit repurchase program ($112 million in the third quarter and $437 million over the last 12 months).

Where things could go wrong

Three things could narrow the cushion. First, part of the recent strength comes from a hot export market. Management said global conflicts are driving strong overseas demand for U.S.-produced natural gas liquids and other products. If that demand falls, margins could, too. Second, borrowing costs are climbing due to higher interest rates. If rates keep rising, coverage could narrow. Finally, Enterprise currently has $6.3 billion of growth capital projects it expects will enter service through the first quarter of 2029. If it significantly boosts growth-related capital spending, it could start outspending cash flow again.

A bankable income stream

For income-focused investors, I'd consider Enterprise's current payout to be rock-solid. It's generating more than enough cash to cover its distribution, and even funded 100% of its capital spending with internally generated cash in the third quarter. On top of that, it has the strongest financial profile in the sector. That makes it a well-funded payout for investors willing to deal with the potential tax complications of investing in an MLP that issues a Schedule K-1 Federal tax form each year.

Matt DiLallo has positions in Enterprise Products Partners. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.