If 2021 was the year you decided to start investing in energy, congratulations! After years of underperformance, the energy sector was the best-performing sector in 2021 with the S&P GSCI Energy Index generating a total return of 60.72%, compared with the S&P 500 total return of 28.7%.
It's impossible to know if we will see similar energy returns in 2022, but there are ways to invest in the industry that have some strong growth tailwinds over the next several years that should translate into big gains for investors. Three energy stocks that look particularly interesting right now are Enviva (EVA), Sempra Energy (SRE 1.08%) and Cheniere Energy (LNG 0.93%). Here's why.
A niche product with big growth potential
Biomass as a source of energy isn't anything new (it's the oldest, actually), but for many years it has taken a back seat to other combustible fuels for a myriad of reasons. Enviva is looking to change that, though, and some recent changes make it a much more compelling investment now than in prior years.
Enviva is in the business of processing and selling wood pellets. On the surface, it sounds like a rather boring business, but wood pellets and biomass are becoming a much more attractive energy option in recent years. For one, it is a drop-in fuel alternative for coal plants and industrial furnaces (think cement and steel) that can significantly reduce full-cycle carbon emissions. Enviva estimates that combining wood pellets and carbon capture at emissions sources is an emissions-negative option for many industries.
It is an attractive option, and it has attracted a lot of customers in recent years. The company has a fully contracted backlog of $21 billion in revenue over the next 14.4 years, and management is developing new processing plants and export terminals to increase production by 40% over the next three years.
One thing that was a knock against Enviva previously was its corporate structure. It was a master limited partnership that paid a unique distribution to a managing partner, known as incentive distribution rights, and limited partners didn't have a say in corporate governance. Earlier this month, though, the company eliminated its managing partner and converted to a traditional C-corporation, eliminating those incentive distribution rights and giving all shareholders equal say in corporate governance. Removing incentive distribution rights will eliminate significant cash expenses and allow it spend more on growing the business.
With a robust contract backlog, a compelling ecological and value proposal for various industries, a clear line of sight for significant growth, and a friendlier corporate structure, Enviva looks like an attractive energy stock right now.
Utility-type dividends with a growth mindset
Investing in utilities is normally a large trade-off for investors. On one hand, you're getting a decent-yielding dividend stock that will reliably throw off cash for decades. The downside is that utilities tend to grow at a tortoise's pace and have underperformed the broader market for more than a decade. One utility that doesn't fall into that category is Sempra Energy. That's because even though it's still largely a regulated utility, it's strategically located in high-growth markets and has some additional growth opportunities outside the conventional utility business.
Sempra's business is divided up into three components: Sempra California, Sempra Texas, and Sempra Infrastructure. Sempra California owns both electric and natural gas distribution utilities in the southern part of the state. Sempra Texas is an electric transmission and distribution utility. And Sempra Infrastructure owns a multitude of energy assets, including two LNG export facilities, natural gas export pipelines to Mexico, and Mexican Energy developer Ienova, to name a few.
The high rate of return for its California businesses, the above-average growth of the Texas market, and investment opportunities outside its regulated utilities have translated into 13% annualized earnings-per-share growth over the past three years, and management is targeting double-digit annual returns over the next five years.
Those may not sound like eye-popping numbers, but over the past 20 years those decent and steady growth numbers have translated into a total return of 990%, versus the S&P 500 total return of 499% over the same time.
Even though Sempra has grown much faster than most players in the utilities industry, it still has one of the higher dividend yields in the business, at 3.3%. Strong yield today with a track record of compounding wealth is an offer that's hard to pass up.
A cash cow cleaning up its act
Cheniere Energy has always been a polarizing company. On one hand, it has relatively predictable revenue thanks to a decades-long contract backlog to supply customers with LNG that accounts for almost all of its production capacity. On the other hand, it's a company that took on a mountain of debt to get its facilities up and running and accumulated billions in losses along the way.
Fortunately for investors, the business is maturing, it has some major growth projects about to commence operations, its financials are looking better, and management is now rewarding shareholders with a dividend. Those things add up to making Cheniere an attractive stock right now.
As of its most recent update, Cheniere expects to bring its most recent expansion project, liquefaction Train 6 at its Louisiana facility, into operations in the first quarter of 2022. That, combined with some optimization strategies that has increased output at existing liquefaction trains by 12%, should give Cheniere a decent growth runway for the next year or so. Beyond that, it expects to commission another expansion at its Texas facility that would boost overall production by another 22%. These are all on top of its existing operations that have contracts in place to generate about $6 billion in revenue annually over the next 17 years.
The stability of its existing operations and these future growth options have given management confidence to start an ambitious debt reduction strategy and return capital to shareholders. Management is targeting $1 billion in debt reduction annually until it achieves an investment-grade credit rating, an annual dividend of $1.33 per share, and share repurchases totaling $1 billion over the next three years.
All of these efforts together should make for a compelling investment over the next several years, especially with demand for LNG expected to grow significantly over the next 20 years. Cheniere's track record for long-term returns is a bit spotty, but it has already cleared some of its most challenging hurdles and is well positioned from here.