The energy sector is on fire this year. The Energy Select Sector SPDR ETF, an exchange-traded fund (ETF) that tracks 23 energy stocks in the S&P 500 index, is up more than 35% so far in 2021. That has absolutely crushed the broader market as the S&P 500 is only up about 5% year to date.
Despite that run-up, several energy stocks appear to have plenty of fuel to continue producing compelling shareholder returns. Three that stand out to our energy contributors are pipeline operators Enbridge (ENB 0.20%), ONEOK (OKE 0.55%), and Energy Transfer (ET 0.44%).
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Increasingly valuable
Reuben Gregg Brewer (Enbridge): Canada's Enbridge is one of North America's largest pipeline operators. It also has a natural gas distribution business and clean energy generating capacity, but those are relatively small operations compared to its pipelines. The thing is, pipelines are seeing material pushback in the United States, suggesting that construction of new assets will be tough to achieve. In fact, the entire energy sector is dealing with a changed view in Washington, D.C., that further clouds the future for midstream assets.
That said, there's a flip side to this. Existing infrastructure could end up becoming increasingly important if it is hard to build new from the ground up. And as one of the largest players in the industry, Enbridge has an entrenched position. That's particularly true in the Canadian oil sands. And with such a large footprint, Enbridge thinks it can keep investing in its business for years to come, planning on roughly 5% to 7% distributable cash flow (DCF) growth through 2023.
ENB Dividend data by YCharts
But what do investors get here? For starters, a fat 7.2% dividend yield that has been increased annually for 26 consecutive years. (The dividend is paid in Canadian dollars so the U.S. figure varies with exchange rates.) The target is for the company to pay out between 60% and 70% of its DCF, a range in which it believes it will remain for years to come. So the dividend appears well covered, a fact that was true even when oil prices were plummeting, and further growth is likely as DCF expands. The best part? The positives here remain true no matter what happens to oil prices.
The capacity to keep growing
Matt DiLallo (ONEOK): Shares of ONEOK have already rallied more than 30% this year. However, the pipeline stock has plenty of room to run. For starters, its stock price is still down by a third since the start of 2020 even though its earnings are growing despite all the volatility in the oil market. Meanwhile, it has lots of room to keep growing, thanks to all the capacity it built in recent years.
ONEOK is coming off a solid year. The pipeline company grew its earnings and cash flow by about 6% in 2020 despite lots of turbulence in the oil market. Meanwhile, it sees its earnings and cash flow growing at a double-digit rate in 2021, driven by producer activity on its systems and the additional capacity from recently completed expansion projects.
The company built enough new capacity in recent years to enable it to handle additional volumes when the oil market recovers. Because of that, it can keep growing its earnings and cash flow at a healthy clip without investing much incremental capital. As a result, it should produce an increasing supply of free cash flow in the coming years. That will further enhance its balance sheet, providing additional support for its 7.5%-yielding dividend.
That increasingly sustainable high dividend yield alone makes ONEOK a stock that investors should consider adding to their portfolio. Add in its upside as the energy market continues improving, and this pipeline stock could keep producing market-crushing total returns over the next few years.
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A promising turnaround energy stock
Neha Chamaria (Energy Transfer): Energy Transfer had a terrible 2020, with the stock losing half its value in just a year's time. Although it's bounced back in recent months, the stock still looks attractive given the midstream company's recovery and growth prospects this year, as outlined by management during its last quarterly earnings release.
Specifically, Energy Transfer is on track to generate significant amounts of cash flow in 2021 even if oil price doesn't budge much going forward. To start, the company's planned capital expenditure this year of around $1.45 billion is half of last year's spending, which should free up a lot of cash. Management expects annual spending on growth to drop further to only $500 million to $700 million in 2022 and 2023.
Second, Energy Transfer expects to close its acquisition of Enable Midstream (ENBL) in the coming months. The $7.2 billion deal should not only be immediately accretive to its free cash flow (FCF), but also save it at least $100 million in costs annually. It's a promising growth move that should expand Energy Transfer's footprint considerably without hurting its cash flow profile: Energy Transfer should be able to generate nearly 95% of its cash flows from fee-based contracts post the acquisition.
Combined, the acquisition and lower capital spending should hugely add to Energy Transfer's FCF going forward, giving it the leeway to strengthen its balance sheet while maintaining a strong dividend payout. Notably, if the company's distribution coverage ratio could average 2.32 times even in an exceptionally challenging year like 2020, it should perform far better in 2021. That pretty much makes Energy Transfer an energy turnaround play for 2021, making it an attractive stock yielding a hefty 7.5% currently.
