If you are looking at adding an income-focused energy investment to your portfolio, you will have to make some hard choices. The similarities and differences among Devon Energy (DVN 0.19%), Chevron (CVX 0.37%), and Enterprise Products Partners (EPD 0.45%) highlight some of the big ones.
Here's a rundown of some things that dividend investors need to consider as they look at income stocks like these in the energy space.
1. Energy prices
Oil and natural gas are commodities prone to dramatic and often swift price changes. This is a fundamental factor that every investor in the energy sector needs to understand because it can have a major impact on a company's top and bottom lines.
Different companies handle this issue differently. For example, Devon Energy is focused on drilling for these fuels, and its financial performance is dictated heavily by energy prices.
Chevron, meanwhile, is diversified across the energy sector, with exposure to the upstream (drilling), midstream (pipeline), and downstream (chemicals and refining) niches, which helps to soften the impact of energy price swings. For example, cheap oil is a net benefit for downstream operations, which use it as a feedstock.
Enterprise Products Partners, meanwhile, is solely focused on the midstream. Its portfolio of infrastructure assets, like pipelines, is largely fee based. As such, demand is more important than energy prices. It tends to have very consistent cash flows over time.
The position of the stocks you buy within the energy sector will have a big impact on their financial performance, price volatility, and dividend paying ability.
2. Dividends
Most dividend investors will likely prefer companies that pay reliable and consistent dividends. But the inherent volatility of the energy sector has to be taken into consideration.
For example, Devon Energy has tied its dividend to its financial performance, meaning it varies along with results. So strong oil prices will lead to higher dividends, and weak oil prices lower dividends (though likely with a bit of a lag). That might not be the best option for investors trying to live off the income their portfolios generate.
WTI crude oil spot price data by YCharts. WTI = West Texas Intermediate.
Chevron, meanwhile, has long attempted to provide investors with a growing income stream. It has increased its dividend annually for 36 consecutive years. But its upstream operations can lead to wide earnings swings.
To accommodate that volatility, it has long focused on having a strong balance sheet. When oil prices are low, it takes on debt to support its dividend and business. During these periods, the dividend payout ratio is likely to be worryingly high, and dividend investors are basically counting on the company's board to continue to support the disbursement in the belief that the oil sector will eventually recover.
CVX debt-to-equity ratio data by YCharts.
Enterprise, meanwhile, focuses heavily on the safety of its distribution. It generally tries to ensure that the distributable cash flows it generates are far above the distribution, so there's little worry about it falling short.
In the first quarter of 2023, for example, this master limited partnership (MLP) had distribution coverage of 1.9 times. That's a lot of room for adversity before a dividend cut would be a risk. Enterprise has 24 years of annual distribution increases under its belt.
3. Growth prospects
Devon, with just an upstream drilling business, is highly reliant on energy prices, but production is also important. If it wants to grow, it needs to drill more. Oil and natural gas prices will largely dictate its financial performance, but production growth is an important secondary driver.
Chevron is in roughly the same boat. But it can invest more in midstream and downstream businesses, too. And it is starting to dip its toes into the clean energy sector as well. In other words, it has a lot more growth levers to pull than a pure-play driller. But, at least for now, oil and natural gas prices are still the dominant force in financial results.
Enterprise owns large infrastructure assets. The way it grows is by adding assets to its portfolio. That can happen through ground-up construction or via acquisition.
The big problem the partnership faces is that it is getting increasingly difficult to build new midstream assets. So growth is likely to be slow, and the distribution yield is likely to make up the lion's share of an investor's total return.
An educated decision
Devon Energy's yield is 8.9% today, but given its variable dividend policy, you can't rely on that figure. That said, investors looking to offset the impact of rising energy prices would likely be getting a bigger dividend payment right when they were faced with higher costs for gasoline and home heating/cooling.
Chevron's yield is around 3.7%. That's relatively modest, but history suggests the company can support it while still growing the dividend through the energy cycle. Value types might want to wait for a deep energy pullback before buying, even though that is likely to be the hardest time to buy.
Enterprise's yield is 7.5%. Distribution growth is likely to be slow, but if you are trying to maximize the income your portfolio generates, it could be the safest choice here, given its predictable business model.
The question isn't really which of these three is the best option, but which is the best option for you.
