The ultra-high yield of energy transfer is excellent. Here’s why you shouldn’t buy it:

energy transfer (ET -0.13%) There is one very big positive thing to boast about. The distribution rate of return amounts to 8.1%. But don’t be so seduced by high yields that you overlook the rest of the story. Indeed, while local production is attractive, the Master Limited Partnership (MLP) that backs it has a very significant drawback. Here’s why you shouldn’t buy Energy Transfer stock.

Energy Transfer: A Good Thing

As already mentioned, the biggest positive here is Energy Transfer’s 8.1% distribution yield. Compare this to the meager 1.3% dividend yield you’d get. S&P 500 3.1% provided by the index or . Energy Select Sector SPDR ETF (XLE -0.63%)represents the energy sector of the S&P 500 index. Based on this comparison, you can see why dividend investors are interested in Energy Transfer.

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Add your Energy Transfer business now. It operates a large portfolio of midstream energy infrastructure, such as pipelines. These assets connect upstream (drilling) and downstream (chemicals and refining) to help move oil and natural gas, and the products they are made from, around the world. Midstream, which is primarily driven by fees, tends to generate fairly consistent cash flows that help support high returns.

If that were the end of the story, investors would be lining up to buy Energy Transfer, but that’s not the case.

There’s more at stake here than meets the eye

Midstream is known for generating stable cash flow, but Energy Transfer ended up cutting its distribution in half in 2020. Enterprise Product Partner (EPD -0.88%) and Enbridge (ENB -0.31%) We didn’t do that and instead continued to increase our quarterly spending.

To be fair, 2020 has been a difficult year for the energy sector as a whole. Oil prices have plummeted as countries around the world go into virtual lockdown to slow the spread of the coronavirus. There is some logic to Energy Transfer’s decision to cut distributions, as it allowed management to hold on to additional cash during an uncertain period. But if you’re looking for a reliable source of income, 2020 distribution cuts will raise big questions.

This raises another problem. In 2016, Energy Transfer agreed to the purchase. williams company (WMB -0.71%). Energy Transfer was left cold as energy markets weakened at the time. Attempts were made to stop the deal, but ultimately succeeded, as execution as planned would result in massive debt burdens, distribution cuts, or both.

Part of that effort included selling convertible bonds, much of which went to the then-CEO. It was a complicated time and there were a lot of moving parts, but if the deal went as planned, the convertible notes would have essentially protected the CEO from distribution cuts.

It would be perfectly reasonable for conservative income investors to look at this and wonder whether the board and management are putting themselves before shareholders. And that concern is probably enough to keep most investors on the sidelines here. After all, other midstream companies like Enterprise and Enbridge are performing much better and still generating attractive returns.

The risk-reward balance is tilted in the wrong direction.

It’s understandable that dividend investors would be attracted to Energy Transfer’s stellar yields. However, yield alone is not a good reason to buy an investment. A closer look at Energy Transfer’s performance shows that its distribution was cut when chips fell in the energy sector.

Given the inherent volatility of the energy sector, it’s difficult to suggest that we can expect the kind of income Energy Transfer delivers. And going back further, it’s not clear whether unitholders can trust the board and management to have their best interests at heart. Overall, there may be better options in the midstream segment, even if they have to accept slightly lower yields.