The past year has been painful for stock investors. The S&P 500 index, which tracks 500 of the largest U.S. stocks, is down 11% at this writing on Sept. 21, and over 19% below its 52-week high. Every single sector is down at least 4% from its high. The only stock sector that's delivered blowout returns so far this year is the energy sector; the Energy Select Sector SPDR ETF is up 70.5% in total returns, with almost 7% of those gains due to dividends.
Needless to say, this has investors -- especially those looking for dividends -- very interested in energy stocks right now. Two in particular are getting a lot of attention: Chevron (CVX 0.75%) and Enterprise Products Partners (EPD 0.18%). This makes sense, considering they're both cash-cow giants, with strong dividends yielding 3.6% and 7.2%, respectively at recent prices. But before buying either of these two giants, investors should also take a close look at Phillips 66 (PSX -2.51%), another diversified giant with a 4.6% yield and a better record of growing its payout.
What makes Phillips 66 different
While both Chevron and Enterprise Products are strong companies (I own Enterprise Products, too), there are some characteristics of Phillips 66 that are very compelling. Most importantly, they're things that can make it a strong investment across the energy cycle, supporting its dividend when we go from today's high oil prices to periods of oversupply that send prices -- and profits for oil producers -- down.
Like Chevron, Phillips 66 is a diversified, integrated oil and gas company. Its operations include midstream operations to gather, pipeline, and store oil, gas, and natural gas liquids; refining and petrochemical operations; and a downstream marketing business to sell and deliver those products to market. Its operations are international, giving it access to oil and gas from some of the largest and lowest-cost oil and gas fields on earth.
But where Phillips 66 differs from Chevron is that it does not have any upstream operations, meaning it does not produce any oil or gas. There's obvious downside to not being a producer, as it means missing out on the upside of high oil prices. You can see how Chevron's free cash flow has essentially tracked oil prices up and down over the past decade:
CVX Free Cash Flow data by YCharts
Cash flows at Phillips 66 and Enterprise Products have also moved up and down with oil prices, but not nearly to the extremes that Chevron's has; that's by and large because its fixed costs to produce oil don't fall when the market price for crude does, but they also don't go up when oil prices are higher.
So while it benefits from higher prices, it also feels the impact of falling prices on its bottom line in a way that Phillips 66 and Enterprise Products don't. And over time, that lack of downside exposure to falling prices makes Phillips 66's dividend more secure in my book.
The counter-argument is that since it doesn't produce oil, it has to buy it to refine it, meaning it pays higher prices when oil prices are up, so that's bad for its bottom line. That's only partly true. Yes, it does pay the higher price, but since refined products like gasoline and jet fuel are priced based on crude prices, Phillips 66 isn't really hurt by that. To the contrary, one of its advantages is its advanced refineries. Since not all crude oils are the same chemistry, not all oils can be processed at any refinery. Phillips 66 has a long history of being able to buy lower-cost crudes other refiners cannot process, boosting its refining margins.
On the other end of the spectrum is Enterprise Products. And while it's a wonderful company, it's less diversified and very focused on the midstream space where all the logistics of oil and gas happens. It's proficient at it, having generated a 12% return on invested capital on average over the past decade. This focus on the midstream has been very good for slow and steady distribution growth, but it hasn't made for a great total return investment. Both it and Chevron have underperformed the S&P 500 by a wide margin over the past decade.
Phillips 66, on the other hand, has actually performed modestly better than the market. It was a rare strong-performing energy stock during the tech stock boom of the past decade.
CVX Total Return Level data by YCharts
A massive part of that higher return has been Phillips 66's superior dividend growth. Since becoming a stand-alone public company in 2012, Phillips 66 has increased its dividend almost fivefold, while Chevron's and Enterprise Products' payouts have grown 58% and 50%, respectively. It's also made some serious moves to position itself as a leader in biofuels, something that should pay off as we transition away from fossil fuels in the coming decades.
Why Phillips 66 is especially attractive now
In recent months, falling oil prices and economic worries have caused investors to send even energy stocks down; of this group, Phillips 66 shares are down more than 25%, and are actually down more than 30% from their pre-COVID highs. I think Mr. Market has once again overreacted due to near-term concerns, creating a wonderful price point to buy this long-term winner at a great price. With a dividend yield well above 4.5% and a long record of stellar dividend increases, Phillips 66 looks like a better buy than Chevron or Enterprise Products right now.
