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3 Top Oil Stocks to Buy in May

By Matthew DiLallo - May 5, 2020 at 8:05AM

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These oil companies have the financial strength needed to endure this downturn.

Oil prices have fallen through the floor this year, briefly crashing into negative territory. While crude has bounced back a bit from its bottom, at around $20 a barrel it's not profitable for most producers these days, and many more oil companies could plunge into bankruptcy over the coming months. That makes most oil stocks too risky to buy these days.

However, there is one sub-sector in the oil market that should make it through this downturn relatively unscathed: top-tier pipeline companies, which are ideal options for investors looking for some oil exposure this month. Topping the list of buy-worthy pipeline companies are TC Energy (TRP 2.32%)Enbridge (ENB -0.61%), and Kinder Morgan (KMI 2.48%).

A pipeline and an oil pump at sunset.

Image source: Getty Images.

Basically immune

TC Energy's business model limits its direct exposure to fluctuations in commodity prices and volumes. That was abundantly clear during the first quarter, as its cash flow surged 15% year over year as expansion projects across its massive gas pipeline system more than offset the limited affect lower volumes had on its oil pipeline business.  

Overall, 95% of the company's earnings come from assets largely insulated from short-term volatility in commodity prices and volumes. The company generates very stable cash flow, which gives it the funds to pay an attractive dividend -- it currently yields more than 5% -- and expand its pipeline network. It has tens of billions of dollars of expansions under construction -- including the controversial Keystone XL oil pipeline -- that should power healthy cash flow growth for the next several years. In TC Energy's estimation, it has the fuel to grow its dividend by 8% to 10% next year and at a 5% to 7% annual rate after that.

Built to endure

Enbridge also operates a durable business. Roughly 98% of its cash flow comes from assets that have no commodity price or volume risk. It also has a strong balance sheet backed by a credit rating that's at the low end of its target range. All that means its roughly 8%-yielding dividend is on solid ground.

Meanwhile, like TC Energy, Enbridge believes it can continue expanding its operations in the coming years as North American energy producers grow their volume to support future demand. In the company's view, it has the financial flexibility to fund enough expansion projects to boost its cash flow by 5% to 7% per year. That could support a similar growth rate in its high-yielding dividend.

A slight bump in the road

Kinder Morgan's business has a bit more direct exposure to fluctuations in commodity prices and volumes. Not only does it produce some oil, exposing it to pricing, but it also gathers and processes natural gas, which has some volume risk. As a result of those factors, Kinder Morgan recently reduced its full-year cash flow guidance by about 10%.

However, the company still expects to generate billions of dollars in cash, which gave it the confidence to increase its dividend by 5%, pushing the yield up to past 7%. While that was a bit more conservative than the initial 25% increase it planned to provide this year, that's because it's taking extra precautions during this downturn. If market conditions improve by year-end, Kinder Morgan could boost its payout up to that much higher rate. It will be able to easily sustain that level since it has a strong balance sheet and is generating a significant amount of free cash after paying its dividend to finance the bulk of its expansion projects.

Weathering this storm with relative ease

Companies that produce oil are getting walloped by lower oil prices, which is forcing many to reduce their volumes since they're no longer profitable. Pipeline companies, on the other hand, are largely immune to these issues since they get paid fixed fees by customers even if they don't use the capacity of their pipelines in many cases. They are therefore on track to continue generating relatively steady cash flow, which will give them the funds to keep paying attractive dividends and expanding their operations. That relative immunity to the oil market's current issues makes them the top options to buy this month.

Matthew DiLallo owns shares of Enbridge and Kinder Morgan. The Motley Fool owns shares of and recommends Enbridge and Kinder Morgan. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Kinder Morgan, Inc. Stock Quote
Kinder Morgan, Inc.
KMI
$18.59 (2.48%) $0.45
TC Energy Corporation Stock Quote
TC Energy Corporation
TRP
$50.69 (2.32%) $1.15
Enbridge Inc. Stock Quote
Enbridge Inc.
ENB
$43.61 (-0.61%) $0.27

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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