An ever-increasing focus on renewable energy, combined with volatile oil and gas prices, has left investors apathetic toward conventional energy stocks. However, oil products and related services continue to enjoy robust demand, offering some extremely attractive opportunities for dividend-seeking investors.
What is vital is to select companies that are well-placed to face the current challenges in the energy markets. Three such companies are Chevron (NYSE:CVX), Kinder Morgan (NYSE:KMI), and Enterprise Products Partners (NYSE:EPD). Let's look at why these three dividend stocks are best equipped to generate steady income for long-term investors.
Chevron, Kinder Morgan, and Enterprise Products Partners all are trading at appealing valuations. Each of the three stocks is trading at an attractive forward EV-to-EBITDA multiple of below 10 times -- much lower than that of the broader market.
As the above graph shows, all three stocks also offer attractive yields. The current yields are much higher than what all three have offered historically. Sure, high yields are reflective of higher perceived risks. But the yields seem outsized compared to the associated risks for the three companies.
Apart from cheap valuations, another statistic that likely reflects the current mispricing of energy stocks is their correlation with oil prices. Consider Chevron stock's correlation with oil prices. With exploration and production operations, Chevron's performance is most exposed to commodity prices among these three.
Chevron stock's correlation with crude oil prices is currently -0.05. That's in contrast to the stock's high positive correlation with oil prices historically. A high positive correlation shows that the stock largely moves in sync with oil prices, as is evident from the above graph. But lately, it hasn't done so, as the below graph with a shorter timeframe shows.
Chevron stock hasn't recovered as much as oil from the lows in March. This could be due to the negative sentiments for oil stocks in general. However, Chevron's strong balance sheet differentiates it from its peers.
As the above graph shows, Chevron is the least leveraged company among global oil majors. That makes it best placed to continue its payouts even if markets remain turbulent for longer. A dividend aristocrat with 32 consecutive years of dividend growth, Chevron is committed to protecting its payouts.
The U.S. Energy Information Administration, in its annual energy outlook, projects 1.9% per year growth in dry natural gas production up to 2025. Kinder Morgan, which moves roughly 40% of total U.S. natural gas, is well-positioned to benefit from the expected growth in natural gas production in the long term.
Involved primarily in the storage and transport of gas and refined products, Kinder Morgan's earnings are not directly exposed to oil and gas prices. That's why it expects just a 10% reduction in its distributable cash flow for 2020 due to COVID-19. That should allow it to easily maintain its dividend and, in fact, raise it next year. With a much-improved balance sheet, Kinder Morgan looks like a screaming buy at current prices for dividend investors.
Enterprise Products Partners
With a debt-to-EBITDA ratio below 4 times, Enterprise Products Partners is one of the most conservative midstream players. The master limited partnership has a track record of generating distributable cash flow in excess of the distributions it pays out. In the second quarter, it generated DCF that was 1.6 times the distributions it paid. Diversified operations and fee-based cash flows position Enterprise Products well for the future.
Like Kinder Morgan, Enterprise Products' earnings are also not directly exposed to commodity prices. All this makes its 11% yield extremely attractive for dividend investors open to investing in MLPs.
The high growth era of energy companies during the shale boom, in part supported by strong oil prices, may be over. But savvy investors understand fossil fuels' key role in meeting the world's energy demands for years to come.
This paves the way for steady dividend income from Chevron, Enterprise Products, and Kinder Morgan. Indeed, oil markets are cyclical and can remain out of favor for years. But they should eventually come out of the trough they are in. Though it's not easy to "be greedy when others are fearful", that's what you need to do to pick stocks when they are cheap.