Rising oil and gas prices have been a key cause of inflation. In fact, the consumer price index rose 7.9% between February 2021 and February 2022, marking the largest year-over-year U.S. inflation reading in 40 years.
A strained supply chain and years of underinvestment may result in higher oil and gas and commodity prices for longer than just the short term. Caterpillar (CAT 0.83%), Deere & Company (DE -0.18%), and Phillips 66 (PSX 1.51%) are three dividend stocks that are benefiting from the current economic situation, but also have the qualities needed to support a long-term investment thesis. Here's what makes each company a great buy now.
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Caterpillar is positioned to capture upside in a strained economy
Daniel Foelber (Caterpillar): Caterpillar's equipment supports various industries in the industrial sector, including oil and gas and mining. So, while it may not directly benefit from the production and sale of oil and gas or other commodities that are rising in price like copper or nickel, its business tends to do better when investment is rising in these industries.
When oil and gas and mining companies aren't making a lot of money, they are less inclined to invest in new equipment made by Caterpillar. But when times are good, there's added incentive to maximize margins by updating fleets with equipment that may be expensive but often results in a lower total cost of ownership.
The same goes for construction. When infrastructure investment is booming, there's more demand for Caterpillar's products. Caterpillar's sensitivity to the health of the global industrial economy is what makes it a cyclical stock whose earnings fluctuate heavily based on the business cycle.
Despite the choppy nature of its short-term results, the company consistently generates sizable free cash flow and raises its dividend. In fact, Caterpillar is a Dividend Aristocrat that has paid and raised its dividend for 27 consecutive years. Caterpillar's ability to capture short-term upside from a variety of industries paired with its growing dividend is what makes the company a balanced long-term buy. Caterpillar stock has a dividend yield of 2.1%.
Downside protection from the conflict in Ukraine
Lee Samaha (Deere): Given the geopolitical uncertainty in the world, particularly in Ukraine, it makes sense to add some protection to your portfolio. One way is through buying stock in agricultural equipment maker Deere.
The argument is relatively simple. Russia and Ukraine are both major exporters of wheat and sunflower oil and, to a lesser extent, soybeans, while Ukraine is a major exporter of corn. In addition, Russia is a major exporter of fertilizer.
The conflict and sanctions have led to soaring crop prices. Moreover, a quick resolution to the conflict is unlikely to lead to a hasty relaxation of sanctions or normalization of trading conditions. These things put pressure on crop supplies, meaning prices could stay elevated through 2022.
High crop prices are usually good news for agricultural equipment manufacturers as farmers tend to invest in new equipment when prices rise. Moreover, the marginal increase in sales in Deere's key North American market due to rising crop prices is likely to offset the loss of sales in Ukraine and Russia -- not least because the former tends to be more profitable for Deere.
In addition, Deere is a significant player in infrastructure and is an excellent way to play an increase in spending on road building. And finally, it's worth noting that Deere is seeing strong uptake in its smart farming and precision agriculture solutions. As a result, an increase in demand for equipment will also lead to increased adoption of Deere's smart technologies. All told, Deere is set to have a strong year, and the stock gives some protection from an extended conflict in Ukraine.
Get your high oil price kicks with Phillips 66
Scott Levine (Phillips 66): As the price of oil consistently trades above $100 per barrel, savvy investors are on the prowl for petroleum-affiliated companies that stand to prosper from higher energy prices -- companies like Phillips 66. A diversified energy company, Phillips 66 operates 13 crude oil and other feedstock refineries in the United States and Europe, which represent a daily refining capacity of 2.2 million barrels of crude oil. In addition, Phillips 66 has a variety of midstream assets, including the operation of more than 22,000 miles of pipeline throughout the United States, some of which the company also owns. Add to all of that the fact that the company provides jet and aviation fuel, and that it's one of the leading suppliers of lubricants in the U.S., and it becomes apparent that the company is doing more than merely pumping oil out of the ground.
The movement in the price of oil benefits the company in a variety of ways, but one aspect that is of utmost importance is the ability for it to improve its financial health. Sure, a healthy boost to the dividend would put a big smile on investors' faces; however, we're looking at the long haul here, favoring management teams that prioritize sound fundamentals. And with Phillips 66 that focus is readily apparent. On the company's fourth-quarter 2021 conference call, for example, Phillips 66 noted that it paid down $1.5 billion in debt during 2021.
While shares of Phillips 66 will likely follow the rise in the price of oil, potential investors need not worry that it's too late to click the buy button. Shares are trading hands at a very reasonable valuation: 5.6 times operating cash flow. Considering the fact that the stock's five-year average multiple is 11.1, it appears that now is a great time to power your portfolio with this diversified energy dynamo.
