Energy is one of the most important parts of the global economy. It's also an area where investors can do quite well -- or just as easily lose their shirts. And it boils down to avoiding the companies with little to no competitive advantages and heavy exposure to commodity prices, and instead finding well-run businesses with solid balance sheets, with strong leaders who know how to allocate resources, and that can generate a rate of return you can be happy with.
In other words, avoiding trying to make a quick gain on "big upside, big risk" stocks that could just as quickly cut your money in half.
Three energy stocks these Motley Fool contributors have identified as "buy now"-worthy are renewable energy producer TerraForm Power Inc. (TERP), oil and gas transportation infrastructure giant Enterprise Products Partners LP (EPD 1.09%), and leading wind turbine manufacturer Vestas Wind Systems ADR (VWDRY 3.35%).
Whether you're looking to invest for growth or income, or invest in renewables or oil and gas, there's something for investors of all stripes here. Keep reading to learn which one is right for your portfolio.
Dive into renewable energy
Travis Hoium (TerraForm Power): Most energy stocks come with some kind of commodity risk related to oil, coal, or natural gas. Even utilities aren't as stable as they used to be as electricity consumption falls and customers begin to have more options with rooftop solar and energy storage. But there are ways to play the energy industry without taking a ton of commodity risk.
TerraForm Power is one of the largest yieldcos on the market today, owning wind and solar power plants and selling electricity to utilities on long-term contracts. As of the end of the third quarter of 2018, the company owned 3.64 gigawatts (GW) of assets, primarily in the U.S. and Spain, and had an average contract life remaining of 14 years.
TerraForm Power uses 80% to 85% of its cash flow to pay a dividend, which has a current yield of 6.7%, with the additional funds going to pay down debt or fund growth projects. Long term, management aims to grow the dividend by 5% to 8% annually, which is a conservative target, and could be done with organic growth for the foreseeable future.
Investors who don't know where to turn in energy today should consider yieldcos like TerraForm Power. The company is stable, pays a great dividend, and avoids a lot of the commodity risks that will make the energy industry a volatile sector in 2019.
Too cheap to ignore
Matt DiLallo (Enterprise Products Partners): Midstream giant Enterprise Products Partners delivered fantastic financial results in 2018. Through the first nine months, the company's cash flow per share was up more than 30% versus the prior-year period, driven by rising volumes across its legacy assets, as well as the positive impact of recently completed expansion projects. That surge in cash flow enabled Enterprise to continue increasing its dividend to investors, with it recently notching its 58th consecutive quarterly increase, boosting it 2.4% overall for the year.
Typically, companies growing both their earnings and dividends will generate market-beating returns. Enterprise Products Partners, on the other hand, lost value in the past year, falling about 7% overall. Because of that, the company trades at a much cheaper valuation, with it currently selling for less than 10 times cash flow, which is its lowest level in years.
That dirt cheap valuation is just one reason why Enterprise Products Partners is a great energy stock to buy right now. Adding to the attraction is that the company currently yields 6.4% and still has plenty of growth in the tank since it expects to finish another $4.5 billion of expansion projects this year and another $1.4 billion in 2020. Those expansions, when added to the company's high-yielding dividend, set Enterprise Products Partners up to generate total annual returns in the 10% to 15% range without any improvement in its valuation multiple and even higher returns if that number moves back toward its historical average.
A huge tailwind
Jason Hall (Vestas Wind Systems): While both TerraForm Power and Enterprise Products offer investors a solid way to profit from energy with potentially less volatility since much of your returns will come from steady dividends, the thesis for Vestas is built on long-term growth in demand for ultracheap, clean wind energy. The reality is, it's going to take trillions of dollars in global investments to add the additional energy capacity and to replace aging power plants over the next several decades, and wind -- one of the cheapest sources of power available -- will certainly take a big piece of that pie.
As a global leader in the manufacture and service of wind turbines, Vestas is positioned to be a huge part of the future of wind energy, even as the company rides the cyclical nature of turbine demand up and down from year to year.
Its stock price is up 28% from where it was three years ago, but it's actually down about 15% from the mid-2017 peak. Thus is the nature of investing in a cyclical business over the short term. And while the decline isn't great for anyone who bought at the peak, the reality is, it's a great buying opportunity for investors today.
Trading for about 19 times trailing earnings, Vestas shares are very reasonable for investors with a true long-term mentality. Looking out a decade from now, investors who take a "buy on the dip" approach to owning Vestas should do incredibly well.