The energy industry has been on a wild ride over the past several years. From the wild swings in oil and gas prices over the past decade to playing the "will they, won't they" game with extending renewable energy tax credits that have led to big swings in stock prices, investing in energy has been quite the manic affair.
This kind of volatility is off-putting for most investors, especially when looking for long-term investments. Fortunately, not all players in the energy space are investments that will make you nauseous watching their stock chart, and a few offer solid dividends to boot. Here's why investors looking for safer dividends in the energy sector should consider Sempra Energy (SRE -0.20%) and Valero Energy (VLO -0.70%)
But first, what is safe?
It sounds like a silly question, but safety in investing can mean many things. For example, a stock that pays the same dividend for years and can easily afford it could be a "safe" dividend, but a payment that doesn't even keep up with inflation is steadily losing purchasing power. If you're planning to use dividend income in retirement, you probably don't want less purchasing power a decade from now. Similarly, if a slow-but-steady dividend payer consistently underperforms its sector or the broader market, it would make more sense to invest in an S&P 500 or a sector-specific ETF.
So, for the purposes of this exercise, define a safe dividend as a company that has the ability to grow its payout enough to beat long-term inflation and has a reasonable chance of beating the returns of its sector ETF. Once you put that filter up, the options in the energy sector get a lot smaller and make the prospects of Sempra and Valero that much more appealing.
The growth utility
The terms "utility," "growth," and "market-beating returns" rarely go hand in hand. Sure, regulated utilities are some of the most reliable dividend-payers out there. The business is a government-granted monopoly that agrees to set prices and a cap on a rate of return. But a return on equity of 10% or less, and less than double-digit revenue growth, rarely add up to a market-beating stock.
This is one of the things that makes Sempra Energy unique. Its regulated-utility businesses provide a solid, cash-generative foundation upon which the company can invest in some higher-growth, non-regulated segments of the utility space. Its two regulated utility businesses are in California and Texas, giving it one of the largest utility customer bases in the United States. Between Texas as one of the fastest-growing states and a massive need in California to spend on infrastructure resilience, Sempra has a plan to spend about $34 billion between the two states over the next four years. Remember, too, that all this spending comes with a regulator-approved return on equity of 10.1%.
On top of those operations, it has an unregulated business that includes multiple liquefied natural gas export and import terminals, gas pipelines, power generating assets, and a carbon sequestration unit. This segment is a smaller contributor to the bottom line right now, but many of its assets are still under construction. Once those assets go online, it will likely significantly boost earnings and help Sempra continue its 12-year streak of raising dividends.
The best oil investments no one ever talks about
Refining is probably the part of the oil and gas industry that should get more investor attention. While oil prices can impact a refiner's bottom line, they can do well in high and low oil-price environments as long as the price difference between refined products and crude remains large enough. What's more, refineries are fixed assets that don't require nearly as much capital spending to maintain operations as upstream production. Lower capex means more free cash flow, and more free cash flow means safe dividends and greater returns for investors.
In fact, Valero is one of the few companies in the oil and gas industry that has generated a greater total return over the past decade. Valero's playbook isn't like the typical market-beating stock because it isn't growing its refining or ancillary businesses at a high clip. Instead, it buys back mountains of its own stock to reduce shares outstanding, which in turn increases earnings per share and the ability to increase the per-share dividend without handing out that much more in total dividends. Over the stretch shown in the following chart, Valero has increased its dividend by 533%.
There is the long-term threat of declining fossil-fuel demand, but we're still at least a decade away. A decade's worth of market-beating returns and growing dividends and a decade for Valero to make the shift to renewable fuels sounds like an attractive trade-off.