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Despite Its 5% Yield, This Energy Giant's Stock Isn't Worth Owning

Reuben Gregg Brewer, The Motley Fool

If you're looking at the world's integrated oil majors, Italian energy giant ENI (NYSE: E) and its roughly 5.4% yield might pop up on your radar. There are a number of things to like about the company, but also some important negatives. Here's why investors should probably avoid ENI, and here are a couple of alternatives that might be better options for dividend-focused investors.

Some good and bad things

ENI has increased production in each of the past three years, setting a new record in 2018. It expects to keep growing production at around 3.5% a year between 2018 and 2022 as well. Meanwhile, the company estimates that it can cover its dividend and exploration costs at roughly $52 per barrel of oil. And it has sizable investments in Africa and the Middle East, providing notable exposure to low cost oil markets into which other oil majors have been less inclined to venture.  So far, there are some pretty good reasons to like ENI.   

A man writing in a notebook with an oil well in the background

Image source: Getty Images

However, ENI's upstream drilling operations are much larger than its downstream refining business. So it isn't as diversified as many of its integrated oil major peers. And ENI's financial debt-to-equity ratio, at around 0.52, is the highest among its closest competitors. The heavy use of leverage isn't new, with the Italian oil giant routinely at the top of the group. For comparison, Exxon's 0.12 debt-to-equity ratio sits at the lower end of the peer group, and Royal Dutch Shell's (NYSE: RDS-B) 0.25 is roughly in the middle. This is notable because during the deep oil downturn that started in mid-2014, ENI's use of leverage and heavy exposure to drilling led to a dividend cut. That's something income investors need to keep in the back of their minds, noting that oil is a highly volatile commodity.   

If high leverage and a history of cutting dividends aren't enough to dissuade you from investing in ENI, there's one more big issue. ENI might not have your best interests at heart because, according to the company, "the Italian Ministry of Economy and Finance has de facto control" of the oil giant via a roughly 30% ownership stake. In other words, there's a good chance that ENI will do what's best for Italy before it does what's best for individual shareholders when times get tough. This is not a great option for most investors.    

Some alternatives

If you are still enticed by ENI's yield, then you'd probably be better off looking at Shell and its 5.8% yield. Not only do you get a larger yield, but Shell was able to maintain its dividend through the downturn that led to a cut at ENI. To be fair, Shell's dividend has been stuck at the same level for several years, but there's a good reason for that. 

E Financial Debt to Equity (Quarterly) Chart

E Financial Debt to Equity (Quarterly) data by YCharts

Shell used the downturn to make an opportunistic acquisition, buying the BG Group for a huge $50 billion or so. It was a strategic move to help Shell shift its business mix more toward natural gas, which is expected to be an important transition fuel as the world increasingly favors cleaner energy sources. To pay for the deal, which led to a material increase in the company's debt load, it started to sell noncore assets. These transactions, meanwhile, were used to fine-tune its portfolio even more. With most of the heavy lifting done on the disposition front, Shell's balance sheet is in good shape again. And, at the same time, Shell is looking to the future in a different way, increasing its exposure to renewable power

If you are interested in ENI, Shell looks like a financially stronger entity with a better dividend history and still-solid long-term prospects, even as the energy industry shifts in a cleaner direction. But if you are of a more conservative persuasion, you might prefer the nearly 6% yield offered by Enterprise Products Partners (NYSE: EPD).

Enterprise is one of the largest midstream limited partnerships in North America. It is set to benefit as onshore U.S. energy production increases in the years ahead. However, as a midstream company, it owns the pipes and other assets that help move oil and natural gas from where they are drilled to where they eventually get processed and used. This is a largely fee-based operation, which effectively protects investors from the volatility of oil prices.

E Dividend Yield (TTM) Chart

E Dividend Yield (TTM) data by YCharts

Enterprise is in the middle of a key business transition right now, as it looks to self-fund more of its growth so it can minimize the number of units it issues to fund growth projects. That has slowed distribution growth into the low single digits, but once the transition is complete, it should return to the mid-single-digit space. With 59 consecutive quarterly distribution increases behind it and a distribution coverage ratio of 1.5 times in 2018, Enterprise should be pretty enticing to income investors. Add in more than $5 billion in growth projects to the story and one of the lowest leverage profiles in the midstream space, and this high-yield energy stock starts to sound even better.   

Not worth the risk

ENI has some notable positives, but you have to balance that against the negatives of high leverage, a history of dividend cuts, and de facto government control. All in all, despite a generous yield, it's just not worth the risk. Investors would be better off looking at higher-yielding peer Royal Dutch Shell as it prepares for a clean energy future. Or higher-yielding U.S. midstream giant Enterprise Products Partners, which pulls out the risk of oil price volatility. Both have strong fundamentals, solid prospects for the future, and notably less baggage.

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Reuben Gregg Brewer owns shares of ExxonMobil. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.