The oil and gas sector is a volatile place right now, and there's a lot of danger. But there's also opportunity -- if you know where to look.
Here's why it could be better to invest in pipeline stocks instead of oilfield services stocks for now.
From boom to bust
There was a time and place for oilfield services stocks like Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL). That time was from the dawn of the shale revolution in about 2005 to just before the oil crash of 2014. In addition to being global industry leaders, they were instrumental in developing, servicing, and supporting many of the onshore and offshore oil and gas fields that helped the U.S. become the leading oil and gas-producing country in the world. Schlumberger and Halliburton continue to be global companies. For example, in 2017, 2018, and 2019, around two-thirds of Schlumberger's revenue came from regions outside of North America, namely the Middle East and Asia.
When oil prices were high and drilling rigs were getting contracted left and right, the oilfield services business was thriving. But today, upstream oil investment is at a 15-year low and the U.S. rig count is below 300 -- representing the lowest level since Baker Hughes began tracking the data in 1987. This has pummeled the businesses of oilfield services companies.
At the end of the day, these companies depend on demand for products and services used for drilling, completing, and producing hydrocarbons. With oil prices down and uncertainty high, producers are delaying selling the oil they already have access to in the hopes that prices will rise down the road. Simply put, if producers aren't even interested in selling the oil they have, they probably aren't interested in drilling too many new wells, either.
Decreases in free cash flow and net income pressured both Halliburton and Schlumberger to cut their dividends by 75% a few months ago. Since the beginning of 2014, Halliburton stock has lost 74% of its value and Schlumberger stock is down 79% at the time of this writing.
A better alternative
Pipeline companies are responsible for transporting and storing natural gas, oil, and other valuable products. They can be fairly boring and predictable, but this consistency can be good for your portfolio.
Pipeline giants like Enbridge (NYSE:ENB) and Kinder Morgan (NYSE:KMI) couldn't be more different from Schlumberger and Halliburton. Unlike most energy companies, Kinder Morgan and Enbridge are able to counteract volatile commodity prices by generating most of their revenue from predictable fee-based or regulated customers.
More than 90% of Kinder Morgan's cash flow comes from "take-or-pay and fee-based" sources. Nearly all -- 98% -- of Enbridge's cash flow is cost-of-service, fixed-fee, take-or-pay, or priced based on a competitive tolling settlement.
As a result, these companies can remain largely insulated from the cyclical nature of commodity prices.
For income investors, pipelines provide a safer alternative to oilfield services companies.
On the dividend side, both Enbridge and Kinder Morgan expect distributable cash flow (DCF), which is the cash flow eligible to be given to shareholders, to exceed dividend obligations. Enbridge expects 2020 DCF to be in the range of $4.50 to $4.80, the midpoint of which is double its dividend obligation of $2.30 per share for the year. At $0.55 per common share, Kinder Morgan's first-quarter DCF was about double its dividend of $0.2625, a good sign for the health of the company's dividend.
Better but not perfect
Pipelines are stable, but they aren't immune to downturns in commodity prices. As a precaution, Enbridge increased its liquidity by $5 billion to $14 billion, reduced 2020 costs by $300 million, sold $400 million in assets, and deferred 2020 growth capital spend by $1 billion. Kinder Morgan expects full-year 2020 "DCF to be below plan by approximately 10% and adjusted EBITDA to be below plan by approximately 8%." It's also cutting its expansion outlook by 30% for 2020. Enbridge yields 7.7% and Kinder Morgan yields 7% at the time of this writing.
Lower risk, higher income
Although the prices of oilfield services stocks are down substantially, the value propositions for these companies simply aren't appealing right now. Instead, consider pipeline companies that reduce the risk of investing in the energy sector while also providing dividends to potentially boost your wealth.