Energy businesses can be risky investments as high capital requirements sometimes conflict with commodity price volatility that affects cash flows. At times, though, investors throw the babies out with the bathwater, and there are opportunities to add to this sector of your portfolio.
The three businesses below offer diversity in the energy sector, minimize reliance solely on commodity prices, and offer solid dividend yields thanks to the drop in share prices from the COVID-19 pandemic and related oil price declines.
As one of the world's largest independent oil refiners, Valero Energy (VLO -1.43%) is dependent more on refining margins than the specific price of crude oil. But they are interrelated, and consumer demand ultimately is a major driver of both. The pandemic has thrown oil markets into turmoil, and Valero has not been immune. According to the International Energy Agency (IEA), 57% of global oil demand is determined by mobility, which has been significantly affected by lockdowns imposed to slow the spread of the pandemic.
Valero's main business is its petroleum refineries, which contributed 95% of revenue in 2019. It also owns 14 ethanol plants and operates Diamond Green Diesel, North America's largest renewable diesel plant, in a joint venture with Darling Ingredients (DAR -3.10%). Though currently small relative to petroleum, revenue from the growing biodiesel segment increased 80% year-over-year in 2019.
The company's share price has recovered from recent lows, but it still sells near its lowest level in three years. And thanks to consistently increasing dividends, it has an impressive 5.8% yield.
NextEra Energy (NEE -2.91%) gives investors exposure to both a utility and the growing renewable energy sector. The Florida-based company owns Florida Power & Light, the largest regulated utility in the U.S., as well as Gulf Power, which serves the northwest part of the state. Its other subsidiary is NextEra Energy Resources, which along with its affiliates is the world's largest generator of wind and solar power.
The IEA says that renewable energy has been the most resilient in the sector during the pandemic. Though growth of renewables will be below pre-pandemic expectations, global use of renewables is expected to still increase by 1% in 2020, and expansion projects for solar, wind, and hydro power will lead to a 5% rise in renewable electricity generation for the year.
NextEra announced a $2.5 billion equity raise in February, when the share price was 10% above today's level. With interests in both the predictability of a utility, and the growth opportunities associated with wind and solar renewables, NextEra immediately gives investors diversity with one holding.
Kinder Morgan (KMI -0.71%) also gives investors diversity, as a midstream oil and gas company and one of the largest energy infrastructure companies in North America. Its approximately 70,000 miles of natural gas pipelines and 1,200 miles of natural gas liquids pipelines make up almost two-thirds of its business, and transport about 40% of U.S. natural gas usage and exports.
With about 92% of its cash flow coming from take-or-pay and fee-based contracts, the business should theoretically be mostly independent of commodity prices. In reality, the share price can move with commodity swings, giving investors an opportunity to get a high dividend yield with potential for upside capital gains.
In recent years, the company has focused on lowering debt and financing project growth and dividends with cash flow. Due to the uncertainties related to the pandemic, it recently only raised its dividend 5%, rather than the planned 25%, which still compares nicely to the many energy companies cutting capital spending and dividends in this environment.
A diverse income mix
These three energy companies represent a nice mix of income from dividends and potential for future growth. While the share price of each has risen from recent lows, looking forward should give investors less uncertainty and more security for collecting solid dividends. No single sector should be overweight in any portfolio, but for the portion in the energy sector, investors should look at buying any or all of these three right now.