If you are building a diversified portfolio, you'll want to add some exposure to the energy sector. The high price of oil today, while the broader market is struggling, shows why this could be beneficial.
But you will want to tread carefully, making sure that the passive income streams you add to the mix can hold up over time when oil prices eventually start to fade. Chevron (CVX -0.33%), Magellan Midstream Partners (MMP), and Phillips 66 (PSX -0.23%) all look like they have what it takes to pay you dividends for years to come.
1. Big and strong
If you are just looking for one energy stock, then integrated energy giant Chevron -- with its $270 billion market cap -- should be at the top of your list. For starters, it is large and diversified across the entire energy market, from the upstream (production) to the downstream (chemicals and refining). That helps to even out performance over time, though oil and natural gas prices are still the driving force of earnings.
The company has a long history of financial discipline as well, with a debt-to-equity ratio that is generally toward the low end of its peer group. This allows the company to fall back on its balance sheet during the inevitable lean years in the highly cyclical energy industry to support its capital spending needs and dividend.
The biggest testament to this is the fact that Chevron increased its dividend in 2020, despite the fact that it was a terrible year for energy prices. The company's annual streak is now up to an impressive 35 years, which makes it a Dividend Aristocrat.
With a generous 4% dividend yield and a long-term view of the energy market, Chevron could easily be a one-and-done energy stock for your portfolio.
2. Milking the middle
Magellan operates oil and refined-products midstream assets, including pipelines and storage facilities. This business is largely fee-based, meaning that the master limited partnership (MLP) charges for the use of the assets. The price of the products flowing through the system aren't as big a deal as demand, which is likely to remain strong for many years as the world slowly transitions from carbon fuels to cleaner energy sources like solar and wind power.
It's worth highlighting that, despite the massive drop in demand in 2020, Magellan still managed to support its full-year dividend that year. It has increased its dividend annually since its initial public offering in 2001.
There are two notable facts here. First, Magellan has one of the strongest balance sheets in the midstream sector, with a ratio of debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) of roughly 3.8 times. That gives the MLP room to lean on its balance sheet when times get tough.
And it targets covering its distribution with distributable cash flow by roughly 1.2 times, which may seem lean compared to some peers but has historically been considered a strong number.
There are other names you might consider here, such as larger Enterprise Products Partners or Enbridge, but Magellan's hefty 8.7% distribution yield is definitely worth a close look if you are trying to maximize the passive income you are generating.
3. A solid streak downstream
Phillips 66 has the least-impressive streak of dividend increases on this list at just 10 years or so. But it is hard to blame the company for that because it only became a stand-alone company about, well, a decade ago when it was separated out from pure-play oil producer ConocoPhillips. So, like Magellan, it has hiked its payout each year of its existence, which is a worthy record, especially given that the downstream refining business is notoriously volatile.
The company actually has some diversification going on, too, with operations in the midstream pipelines sector, refining, chemicals (via a joint venture with above-mentioned Chevron), and a marketing business that distributes gasoline and other products. So refining is the core, but it isn't the only business supporting the company's 4.7% dividend yield.
The big story here, however, is that Phillips 66 had a terrible year in 2020, when demand for oil plunged during the early days of the pandemic, losing $0.89 per share. The company leaned on the balance sheet and supported the dividend, and now that things are better, it is reducing leverage. With that kind of playbook, reminiscent of key partner Chevron, passive income investors should feel pretty confident owning this high-yield stock, though it is probably the most aggressive option on the list.
One or more should do the trick
If you only plan on adding one dividend-paying energy name to your portfolio, then Chevron is probably the best choice on this list. If you are looking to maximize the passive income you generate, Magellan deserves your attention. Phillips 66, meanwhile, would make a nice pairing with a more-boring name, as it continues to prove out its dividend bona fides in a historically volatile niche of the energy patch.
