Oil prices have been strong all year. In fact, West Texas Intermediate (WTI) prices, the U.S. benchmark, are right around $85 per barrel. And natural gas prices are also recovering from their spring and summer lows. Yet, the energy sector is down 2% year-to-date, sharply underperforming the S&P 500.
Granted, the energy sector gained 131% in the two-year period from 2021 to 2022. So a slowdown shouldn't come as a surprise. What is surprising is how cheap many top energy stocks are today. And a big reason is the years of underperformance leading up to 2021, paired with strong earnings growth.
Here's why Devon Energy (DVN 0.19%), Kinder Morgan (KMI -0.64%), and Phillips 66 (PSX -3.71%) are three excellent high-yield dividend stocks worth buying now.
Image source: Getty Images.
Devon Energy: Poised to profit
Devon Energy is an exploration and production company that produced 658,000 barrels of oil equivalent per day last quarter. About 64% of the company's production came out of the Delaware Basin in west Texas and eastern New Mexico.
Devon's concentration in U.S. onshore oil and gas, and particularly the Delaware Basin, offers investors a simple way to invest in the growth of U.S. shale production and oil and gas exports. Its second quarter saw record oil production and a breakeven funding level at $40 per barrel, meaning Devon can afford its current capital spending plans even if prices are more than cut in half.
Management also outlined its free cash flow (FCF) targets in its Q2 investor presentation. The company expects an FCF yield of 7% at $70 per barrel, a 9% FCF yield at $80 oil, and a whopping 10% yield at $90 per barrel. An FCF yield is the FCF per share divided by the share. Most companies would love a 7% FCF yield. But a 10% FCF yield is truly incredible and shows how much cash flow Devon can generate at higher oil prices.
Devon Energy has a variable dividend -- something that will appeal to investors who prefer upside potential over consistency. After reaching a 52-week low on Wednesday, Devon Energy stock is certainly worth buying on the dip.
Kinder Morgan: A safe midstream major
Kinder Morgan is one of the largest natural gas, carbon dioxide, and liquids pipeline operators in North America. After the company slashed its dividend in 2015, it has been steadily increasing it every year. Now the stock trades at 14.9 times earnings and has a dividend yield of 6.8%.
What separates Kinder Morgan from its peers is capital allocation and positioning. The company entered the oil and gas crash of 2014 and 2015 with a highly leveraged balance sheet and an overextended asset portfolio, which left it bruised and battered in the years to follow. Since then, Kinder Morgan has largely kept its promises to investors to pay down debt and keep its spending within reason so that it can support dividend payments with cash.
Over the last few years, Kinder Morgan finished construction of some major pipelines that connect the Permian Basin to export terminals along the U.S. Gulf Coast. It also made a few small to medium-sized acquisitions in both legacy assets and low-carbon opportunities in renewable natural gas, which is natural gas produced from waste, manure, or wastewater instead of fossil gas.
Similar to Devon Energy, Kinder Morgan has a strong asset portfolio in Texas. So if you believe in the growth of U.S. oil and natural gas exports, then Kinder Morgan is set up nicely to support increased takeaway capacity out of the Permian Basin.
If we look at Kinder Morgan's capital expenditures over the last few years, they are still down big compared to pre-2015 crash levels.
KMI Capital Expenditures (TTM) data by YCharts
In sum, Kinder Morgan is a good option if you're looking for a high dividend yield but also don't want to invest in a midstream company that is aggressively allocating capital in a way that may backfire down the road.
Phillips 66: A downstream dynamo
Refining stocks have been on a tear in 2023, and Phillips 66 is no exception. The stock is up a staggering 49% over the past year and 139% over the last three years. And yet, like Devon Energy and Kinder Morgan, there's a case to be made that Phillips 66 is still cheap.
Refiners have an advantage in the current operating climate. Last quarter Phillips 66 lowered its operating costs and had a crude utilization rate of 93%. Utilization rate is basically how much crude a company is refining relative to its capacity. A crude utilization rate of 93% means the company's refineries are operating at near-full capacity.
The efficiency is mirrored in the company's results. Phillips 66 went from crude utilization rates in the mid-70s during the pandemic and record-low earnings to record-high earnings. The earnings bonanza has compressed the stock's price-to-earnings ratio down to just 5.2.
PSX EPS Diluted (TTM) data by YCharts
While Philips 66 is unlikely to keep up this pace, the unprecedented earnings increase provides a large margin of error for earnings to fall and the stock to still be cheap. Philips 66 is in an excellent position to pass along the impact of higher costs directly to consumers. In this vein, it is an inflation-resistant dividend stock. With a yield of 3.4% and plenty of upside potential, Phillips 66 is worth considering now.
Take a basket approach to the energy sector
The oil and gas industry is in the cat-bird seat today due to strong commodity prices and its inflation resistance. However, the industry will always be volatile and is prone to massive swings to the upside and the downside.
One of the simplest ways of offsetting this volatility is through diversification. There are high-yield opportunities across the upstream, midstream, and downstream industries. Devon Energy, Kinder Morgan, and Phillips 66 provide good starting points, but there are plenty of other companies worth considering as well.
