With the 10-year Treasury rate now at 4.5%, investors should demand more from their income stock investments. After all, if a company offers little growth and a much lower yield than the risk-free rate, then the risk might not be worth taking.
Midstream companies Enbridge (ENB -1.21%) and Kinder Morgan (KMI -0.64%) yield 7.7% and 6.8%, respectively, while Diamondback Energy (FANG 0.32%) offers investors a low ordinary dividend yield but plenty of upside from a variable dividend and high oil and gas prices. Here's why three fool.com contributors believe these energy stocks are worth buying now.
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Enbridge's "once in a generation" opportunity
Scott Levine (Enbridge): High-yield stocks are great. But ultra-high-yield dividend stocks like Enbridge? Now there's an excellent chance to generate considerable passive income.
With an enticing 7.7% forward yield, Enbridge is a compelling option, one that is especially attractive considering its low price tag and the company's recent acquisition, which helps to make the dividend look even more secure.
Midstream operations represent Enbridge's bread and butter (it claims to transport 30% of the crude oil produced in North America), but the company took a major step toward diversifying its portfolio earlier this month. Inking a definitive agreement with Dominion Energy, Enbridge will acquire several natural gas utilities for $14 billion.
There's no denying Enbridge's enthusiasm for the deal. CEO Greg Ebel said, "Adding natural gas utilities of this scale and quality, at a historically attractive multiple, is a once-in-a-generation opportunity."
With this transaction, Enbridge claims it will own North America's largest natural-gas utility platform. The increased natural gas operations mitigate the risk associated with an extended downturn in oil prices.
Although management is enthralled with the acquisition, investors haven't provided such a ringing endorsement. Whether it's due to their frustration that Enbridge didn't allocate capital in a way that would be more directly beneficial to them, or they're fretful of the company's more debt-laden balance sheet, investors have clicked the sell button in response to the deal.
These concerns seem shortsighted, though, leaving long-term investors with a great opportunity to buy the stock on sale. Currently, shares are valued at 7.2 times operating cash flow, a discount to the stock's five-year average cash-flow multiple of 9.7.
An energy company focused on returning capital to investors
Lee Samaha (Diamondback Energy): There's no point ignoring the elephant in the room: Diamondback is an oil and gas exploration and production company, meaning its earnings and ability to pay a dividend are led by energy prices. As such, the stock is only really suitable for investors looking to capture some upside from an elevated price of oil.
That said, Diamondback also offers downside security, at least regarding dividends. Similar to many oil companies, Diamondback pays a base dividend (which it intends to maintain) and a variable dividend that fluctuates with its earnings and cash flow. Moreover, the company uses commodity hedging to protect the base dividend down to oil prices at $40 a barrel.
The current base dividend is $0.84 a quarter, or $3.36 annually, for a 2.2% yield. Management claims "hedge protection at $55 oil," so anything above that implies upside exposure to the price of oil and therefore variable dividends.
The current dividend rate (the base plus variable rate) is $6.88, meaning a 4.5% yield at the current price. In addition, Diamondback uses share buybacks to return capital to investors.
And the company is backed by a strong track record of improving estimated net proved reserves. This is always a crucial number to look at because the actual value of an oil company lies in its long-term production. The good news is that Diamondback doubled its estimated net proved reserves from 2018 to 2022, so they stood at 2.033 billion barrels of oil equivalent -- Diamondback produced 151 million barrels of oil equivalent in 2022.
All told, the company has a good track record of increasing reserves, and the stock is an interesting strategy that provides downside protection and upside potential to the price of oil.
Kinder Morgan provides a vital service to the energy industry
Daniel Foelber (Kinder Morgan): Kinder Morgan has quietly turned into one of the safest and most effective dividend stocks on the market. The recipe for a quality income stock is a reliable and growing dividend and a high yield, but many blue chip dividend stocks have yields of less than 3%.
Amid higher stock prices, it has become increasingly difficult to find a safe dividend stock with a yield over 4%, so when you come across a stock like Kinder Morgan with a dividend yield of 6.8%, it certainly stands out relative to other opportunities.
The company is in the energy infrastructure business, and its objective is to build assets that can generate steady cash flows for decades to come. The issue is that new pipeline or storage assets can cost hundreds of millions of dollars -- if not billions -- so there needs to be a payoff to generate a return on investment that's worth the risk.
In Kinder Morgan's favor is a strong U.S. oil and gas industry paired with a growing natural gas export industry, and these trends support the need for additional energy infrastructure. The business model isn't complicated: More pipelines mean more cash flow, which can fuel a higher dividend.
The best part is that Kinder Morgan contracts out its assets to mitigate much of the impact price movements in oil and gas can have on its cash flow.
The long-term risk is the gradual decline in oil and gas use, which reduces the value of the company's existing infrastructure and makes it hard to justify new energy infrastructure projects. But given the growing importance of energy security and the role that natural gas is likely to play in the energy transition for decades to come, this risk doesn't look like it's going to meaningfully impact Kinder Morgan anytime soon.
All told, Kinder Morgan is a top high-yield dividend stock that can generate some serious passive income for your portfolio.
