In this episode of Industry Focus: Energy, Nick Sciple and Motley Fool contributor Matt DiLallo bring you some energy headlines from the markets.
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This video was recorded on April 2, 2020.
Nick Sciple: It's Thursday, and we're going to be diving into some dividend stocks to consider buying during the coronavirus market disruption. Joining me to break it all down is Motley Fool contributor Matt DiLallo. Matt, how's it going?
Matt DiLallo: It's going as well as can be expected in these times.
Sciple: Yeah, it's been a wild couple of months in the stock market, crazy volatility, when a lot of the stats you can compare to are 1929-1930, you can tell a craziness is going on, how have you been personally investing during this time?
DiLallo: You know, I really got back some cash, it's just kind of how I invest and so I've been dabbling putting some of that to work, focusing mostly on companies that I know can survive, like, your big, big cap stocks, things that pay good dividends, have strong balance sheets and that are just, you know, 20%, 30% cheaper than before.
Sciple: Absolutely. And we're going to talk about some of those dividend stocks later on the show. We do have a couple of news items that we have to dive into. The first one came, really, right before we started recording, so it's about 10:45 eastern time this morning, 15 minutes ago maybe, President Trump tweeted about what could potentially be some significant cuts coming out of Saudi Arabia and Russia.
The tweet said, "Just spoke to my friend MBS, Crown Prince of Saudi Arabia, who spoke with President Putin of Russia, and I expect and hope that they will be cutting back approximately 10 million barrels and maybe substantially more, which if it happens will be GREAT for the oil and gas industry." When you see this cut, obviously, we'll have to see what the Saudis and Russians actually do? But 10 million barrels a day is a significant cut, Matt.
DiLallo: Yeah, that's significant. So, the oil industry pumps about a 100 million barrels a day, so you're taking out that much; however, they think demand is going to drop 20%, so this is really just a drop in the bucket, because demand has been falling for weeks now, so there's got to be more cuts coming, there's just nowhere to put all this oil, so they have to do this because there's nowhere for the oil to go. But it's still not enough, so America is going to have to do something.
And it'll be interesting to see what our response will be, because they're not doing this for free, you know, they did this initially to hurt our oil industry, but it's really backfired because the coronavirus outbreak has turned out to be much worse than people expected.
Sciple: Yes, we keep saying that double one-two punch of coronavirus, plus this massive surge-up in supply. What could possibly be on the table here, because we have talked about, part of this move has been to potentially break U.S. shale and force up the price of oil across the board, when they can boost production back up. What do you think could possibly be concessions from the U.S. to get these cuts to happen?
DiLallo: Well, I think, initially what Russia was saying is that, the United States producers were still growing their production, so here's Russia holding back and U.S. is continuing to grow, and they just got sick and tired of that and they're, like, "Okay, we're going to take advantage of the situation and really put the pressure on the U.S. producers to stop growing." And I think they might actually have learned their lesson this time, at least for the near-term.
There's been like a big pushback from investors to stop growing production as fast as possible, that's why we see dividends and stock buybacks. But I think now U.S. producers actually have to cut back. They've stopped drilling in some places and they've laid down drilling rigs, but that's just not enough, they have to actually turn off the physical pumps. And I've seen numbers, like, Texas might cut 20%, and I think things like that have to happen, which is things that just are unheard of in the industry.
Sciple: Right. And even with Texas cutting 20%, you're still going to be, you know, say 7 million barrels a day oversupplied. So, either way, we're going to be in a significant oversupply in the market, which creates difficult conditions for shale oil companies.
We've talked about in the past that there are probably some bankruptcies coming down the line for shale E&Ps, whether or not the coronavirus disruption took place. Well, we saw the first of those come to fruition this week with Whiting Petroleum being the first shale company to declare bankruptcy so far this year. Not only did they declare bankruptcy, though, Whiting Petroleum's Board approved $14.6 million in cash bonuses for top executives days before they declared bankruptcy.
When you see this happen, Matt, does this surprise you at all coming from the shale industry?
DiLallo: Unfortunately, it doesn't surprise me, but it's still shameful, you know. They have drilled their company into the ground, taking up too much debt. And you know, they had several years to prepare for this. And they did little things here and there. But then, what are they getting a bonus for? For destroying the company? And for it to be paid in cash when there's people that they're laying off, it's just shameful, but it's practiced in the industry, and this is something that really needs to stop.
Sciple: Right. This is legal. So, this is the thing, I mean, there's not really a legal repercussion here. The thing is, you know, you need to, kind of, not invest in these sorts of folks, don't support them, and really call it out when you see it. And it's not just the management here that you need to shame some, this is the Board, I mean, the Board approved this compensation package, a lot of these folks are long standing Board members. You look at the Chairman of the Board, who has been there since 2003, has received about $1.5 million in compensation over the past five years. Clearly, isn't putting a lot of resistance to management when they ask for these sorts of things. So, this is certainly concerning. I think we can expect more of that this year as there's disruption in the oil market.
And to be honest, some of these bankruptcies were coming down the line whether or not the coronavirus disruption took place. So, when folks say, "We would have got through this, but for the coronavirus," don't necessarily believe that for all these shale folks.
Moving into our main topic for today, we're going to talk about some dividend-paying stocks. We got a listener question from Mike. Mike asked "What are the prospects for energy pipeline companies? Is Kinder Morgan (NYSE:KMI), Enbridge (NYSE:ENB), MLPs like Magellan Midstream (NYSE:MMP), etc., in the current environment? What are the best current investments? Love the show. Keep up the good work."
Matt, any thoughts on those midstream pipelines? Well, first, before we get into those specific companies, just more broadly, we talked about the trouble that the E&Ps have had, these bankruptcies taking place. How are these going to affect midstream companies, if at all?
DiLallo: Yeah, I think that's the big unknown right now. One of the things that Whiting did before they declared bankruptcy is, they drew everything on their credit facility. And so, basically, it's like a credit card that companies have with banks and what that will do is that will give them cash to operate as they work through things. And the idea is, this will give them the money to pay these midstream companies, their employees, their partners that sort of thing.
So, it all really depends on is how the bankruptcy things shake out. Like, in Whiting's case, it's pre-packaged, which means they basically agreed what they're going to do. So, if everybody agrees to it, that means they'll keep these midstream contracts in place. However, we don't know what the next one will be and there's companies out there that have significant exposure to these financially weaker E&Ps and so if they go bankrupt and then they can't work out a pre-packaged deal, they might have to go all the way back and cut midstream contracts oil service contracts. So, we just don't know how it's all going to play out.
And so thus, investors really need to be careful and just keep an eye on basically everything that is risk-related with these companies.
Sciple: Right. Those counterparties are really important, that's why if you can have folks who, their customers are more credit-worthy, particularly, help -- I mean, it's always a good thing to look for, but particularly in this environment, even more important.
Going to these companies that Mike mentioned, Kinder Morgan, Enbridge, Magellan Midstream, any of those pop out to you as particularly attractive or particularly unattractive?
DiLallo: So, Enbridge actually put out an interesting investor slideshow where they went through their counterparty risk, which is, you know they have these long-term contracts, which is great, but if the companies that underpin that goes bankrupt then they're worthless, but it was like 90% of those contracts were with an investment grade counterparties. Now, investment grade is flexible, and if these companies come into trouble, those ratings could go bye-bye, but it does give them kind of a leg-up on some of the other ones.
And then the other thing is volumes are going to fluctuate a lot. And a lot of these contracts are called take-or-pay, which means if the volumes don't go, it doesn't matter and the other thing is the commodity price. So, a lot of these bigger pipeline companies are better insulated from these things. So, like, your Kinder Morgan, your Enbridge, they are a lot safer. Magellan, in particular, they put out kind of like a warning that they see 20% demand decline and so that's going to impact them. But they still believe that they're going to be able to fund their dividend, they're just going to take on more debt, which they can because they have a great balance sheet.
So, you know you're looking at the balance sheet. This is where the balance sheet really matters. And in those cases, all three of those companies really stepped it up before things got bad and so they're better positioned now that things are bad.
Sciple: Yeah, I think, all three of those are on the shortlist of ones that I would be looking at. I think, Enbridge is one, I think, it's particularly attractive given the assets that they have. They are kind of systemically important to the Canadian market when it comes to the pipeline supply there.
Want to talk about too, just more broadly, outside of the ones that Mike mentioned. So, some dividend stocks that you like. I asked you to kind of bring a couple that you're interested in. The first one of these is TC Energy (NYSE:TRP). Matt, what can you tell us about that company?
DiLallo: Yes, so I really took a deep look at each one of these pipeline companies to see which one looks like the strongest. And I think TC Energy, which is formerly TransCanada, they are natural gas focused, and natural gas is going to be a little bit less impacted by all this, even though the industries are shutting down, so you're not going to have as much natural gas demand. However, 92% of the cash flow is backed by these take-or-pay type contracts which just means there's no volume or commodity price for us, so that's very stable cash flow.
Most of them are investment grade shippers. And the big thing, I think, with them is a 40% dividend payout ratio. So, very conservative, lots of cushion there. They have one of the highest credit ratings in the sector. And so, they're really well-positioned for this.
Now, they are projecting 8% to 10% dividend growth next year and 5% to 7% in the future. I'm concerned with that, but I do like their dividend right now. And I think that as far as, you know, if I'm looking at a pipeline stock to buy, that would be the safest one, in my opinion, right now.
Sciple: So, when you say, "A concern about the dividend; don't expect it to rise this year," can you expound on that a little bit?
DiLallo: Well, they've already increased it this year, but they're saying 8% to 10% next year. And the industry might hold back for the near-term, just given all the uncertainty, they might keep that cash they would have used to raise the dividend, they might go and make an acquisition or just really fortify that balance sheet. I think in this environment they don't need to grow the dividend, at least that fast, maybe you do a 1% just to get to that 21st year, because they've grown it for 20 straight years, so.
Sciple: Right. We're on the way to dividend aristocrat status, you don't want to give that up, right, even if you got to raise it by $0.01, you're going to do what you need to stick on that list.
There's another one, you mentioned Canada, you know there's been a lot of political issues around the pipelines being going on there. Has that affected them at all?
DiLallo: Actually, they just approved the Keystone XL pipeline, which kind of flew under the radar, that was a big deal in the past couple of years, but Trump had pushed it as soon as he got elected. And they just decided that they're going to move forward with that. And they did it because the government of Alberta, which is where all the oil sands companies are located, they're going to help finance this thing, they're pumping, like, a $1 billion in equity plus they're backing a credit facility.
And that's because Canada needs pipelines. The oil price in Canada was like $5 a barrel the other day, because they just don't have any place to store, they don't have any place to get it to market. And so, this will help them in the future, obviously, it won't be ready for -- you know, 2023 is optimistic because you know there's going to be some pushback from environmentalists and landowners and people like that. But it's a project that would really move the needle for them if it does move forward.
Sciple: Yeah, it's been difficult, particularly these further inland producers, it's really hard to get your product to market. I mean, you know there's no way to store it terrestrially and then there's no way to get it out. So, that's a particularly important thing. And then Canada, I think, has been starved for pipelines for a while.
Moving on to your second stock, which one do you bring for us, Matt?
DiLallo: NextEra Energy (NYSE:NEE), which is a utility in Florida, we talked about it before. I think they're one of the best-run energy companies in the country. They've been spot-on with renewable energy, which, you know, is just this huge megatrend. They invest very well as far as looking for returns and, you know, just their business. Now, even utilities, I think, could feel some near-term impact from just the demand that, you know, we're not using much electricity, we're not using much of natural gas, but they've got the balance sheet to get through that. One of the best balance sheets in the industry. They have a little payout ratio, about 60%. So, I like them very much.
Again, the question is, are they going to grow the dividend as much as they say? They say 10% per year through 2022, which is very optimistic right now given we just don't know how the economy is going to respond to all this shutting down for a couple of months, so. But I think they can at least maintain their dividend, then once things get better, they're going to be shining on the other side.
Sciple: Yeah, as a utility, one thing you think about is they have regulated rates. And there could be some restrictions from governments on how much they'll let folks hike up rates given the state of the economy. I mean, obviously, NextEra energy is known mostly for its renewable portfolio, that sort of thing. They do have a small portfolio of pipelines, do you think, is that going to be affected at all by what's going on?
DiLallo: I don't think so, because most of the pipelines are these take-or-pay ones. So, they're not into the gathering and processing, which is further upstream, right by the wells, these are mostly interstate pipelines. And the gas, typically, will flow to utilities that will use it. Now, I think if a utility is going to shut down anything, because of lack of power demand, it will be coal, because coal is the most expensive power source. So, I think coal will go before natural gas. And because natural gas prices have plummeted. And then, I don't think that anybody is going to shut-off a renewable power plant right now. So, I think they're very well protected as far as being able to continue making money on those contracts.
Sciple: Yeah, but, Matt, this raises an issue that I've thought about, maybe I can get your thoughts here. As we've seen this trend over the past several years of coal being replaced by natural gas or renewables, that sort of thing, do you think that this disruption caused by the coronavirus could accelerate that trend at all?
DiLallo: I think so, because coal, in my opinion, it's done. There's no reason to be burning coal when we have clean burning natural gas, which is, I saw a price $1.50 for NCF; that's half of what it was not too long ago. And so that's so cheap and the renewables are getting cheaper and cheaper, especially with, like, all commodity prices are falling, so your steel prices are going to be cheaper, so that's going to make wind cheaper. So, I really think that this will basically help accelerate this trend toward renewables.
Sciple: Yeah, absolutely, we see President Trump, you know go back to another tweet talking about, "Now is the time to invest in infrastructure." If we're going to do that, I really would love to see some more investment in natural gas, renewables, that sort of thing. And I think that's the type of investment that both parties can get onboard with. And these days, it's very difficult to get that done in any sort of way.
Moving away from energy companies, talking more broadly in the dividend space, any companies that you're interested in right now or you've been buying that you think are particularly attractive for dividend purposes?
DiLallo: Yeah. I had a watchlist of the kinds of things that I was looking for to buy if we ever got a big sell-off. And Home Depot (NYSE:HD)is one that was on my watchlist, because I'm renovating my house right now and I've been to Home Depot seventy times. And one day I saw the dividend yield was like 4% in Home Depot. And that's a company that, yeah, it's going to suffer in the near-term, but it's something that, like, Amazon is going to disrupt and we're always going to need to maintain our houses. So, that was one that I bought.
And then Waste Management was another one. Sure, garbage is, you know, that's kind of recession resistant, but this is a different kind of recession. So, I think there's a near-term impact, but long-term, you know, that's a really great, well-run company.
So, those are some of the ones that I bought recently that I'm excited to be able to get at such a cheaper price.
Sciple: I've personally bought Home Depot as well. It ticks off a lot of the boxes I look for in a company. So, it's in this duopoly, it's them and Lowe's. It's really the barriers to entry are going to be very difficult for them. I can't imagine there's a city in the country of any size that doesn't have one of those major hardware stores there. You talk about the type of things that they ship. You mentioned Amazon. Amazon is not going to start shipping 2x4s or any of that sort of thing anytime soon. Just the logistical aspect of it is tough.
And again, whether you like to or not, things break around your house. We have a little sliding door that goes in front of our, kind of, washer dryer at the stack washer dryer thing. And that thing has been slowly, but surely, breaking down day-after-day week-after-week since we've been living at home. And I know I'm going to have to make a trip to Home Depot to fix that. And, you know, they're just going to have that business going forward.
Another thing that I think about too is, a lot of folks my age, younger folks, are getting to that age where they're going to be moving into homes. And a lot of these starter homes, there's an undersupply of starter homes. So, if you can't buy new starter homes, well, maybe you're going to have to buy an older house, which leads to you having to fix more stuff.
So, I think just structurally, Home Depot checks off a lot of boxes. This is a type of business that maybe it's going to be disturbed for a while, but it's a really, really strong franchise.
And I also like the management too. Arthur Blank is a person who -- the Founder of the business -- who I can really respect and get behind. So, I think across the board I like that business.
Another one, I bought MasterCard. I think that's a business that is going to do really great during this period, dividend payer, it's not a massive, massive yielder. And card volumes are probably going to go down slightly. But again, there's some arguments people have made -- I don't know if I'm really onboard with them, though -- that maybe this is going to accelerate the trend away from cash, folks are worried about handling cash, buying more things online. I think, generally this is a company that's going to come out of the backend, that's going to be well-positioned.
DiLallo: Yeah, I definitely agree with you on MasterCard, I bought that too. And then, to your point about renovating houses, my wife and I just bought a house last July, it was a 25-year-old house. And, man, the longer we've been in here, the more projects we added to our list. You know, things that initially didn't bother us, it's like, "Uh, that needs to be painted," or "Uh, that needs to be replaced."
And the other thing is, people that are living in apartments now, they've realized that those apartments get small really quickly. And the space is going to be at a premium and I think you're going to see a big wave of people moving a little bit out to the suburbs and getting some space in a backyard that they can go out in.
Sciple: Yeah, tell me about it. We've been here with the lockdown, I have a large dog, a lab, and they closed all the dog parks in the city and it has been a chore trying to get him exercised without having a backyard and like a place to go run him. And I think lots of other people are noticing that.
While we're talking about it, one other theme that I do think is going to benefit coming out of the backend of this is pets. I don't know, if you've seen, a bunch of my friends have gotten pets in the past week or so. There was an article out of Bloomberg maybe a week or two ago that said New York City had literally run out of foster pets, they didn't have any, because so many people had come and got and picked up pets to help them out, I guess. And I think that's a trend that's probably going to benefit in the near-term from this disruption. And I think that that's a trend that already had a lot of tailwinds behind it.
So, I've been looking at some of the pet companies with IDEXX Labs or Zoetis or even, like, Trupanion pet insurance. Those are all, kind of, themes that I'm looking at right now to invest in.
DiLallo: Yeah. Well, as pet owners, we don't have the kids, but we have two cats. And Chewy is something that we've used for years, and it's such a great company as far as just being ease-of-use. We get our Kitty litter and food delivered to us on a consistent basis, so my wife doesn't have to pick that up at the store. So, they're a good company for us as users.
Sciple: So, there's a list for everybody to look at. Matt, do you have -- I keep asking this for all our guests that come on, because a lot of you all have been working at home for a long period of time even before this coronavirus disruption. And I know I'm kind of adjusting to this process as well. Do you have any tips for those of us who are now working at home on how to navigate that new dynamic?
DiLallo: I love working from home. I'm a bit of an introvert, so it kind of suits me well. But try to keep some sort of set schedule, it's kind of what has been easy for me. But I like to break up my day and go for a walk or go get some exercise. And you just have so much freedom to do that and so I take advantage of that freedom. I spend a lot of time in front of the computer writing, but just getting that fresh air is very helpful. So, definitely do that.
Sciple: Good tips for everybody at home. Matt, thanks, as always, for coming on the show. You know, we had President Trump tweeting right before the show, but likely by the end of the day there could be another tweet that totally reverses everything we discussed today, hopefully not, hopefully we gave some value for the listeners anyway. But always happy to have you on chatting about investing.
DiLallo: Hey, thanks for having me.
Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear.
Thanks to Austin Morgan for his work behind the glass. For Matt DiLallo, I'm Nick Sciple, thanks for listening and Fool on!