You probably don’t think about it, but oil and natural gas are all around you. They are used at the gas station down the street, by the utility that provides your electricity, and in the products you use all around your house. Oil and natural gas are so vital to the modern world that they would be virtually impossible to replace, at least in the short term. Which is why energy stocks should have a place in every investor’s portfolio, even those focused on generating reliable dividends.
Here’s why integrated energy giant Chevron(NYSE: CVX) and its lofty 4.5% yield could be a great pick for you. If you prefer to avoid direct exposure to oil and gas, given their inherent volatility, then you might want to consider North American midstream giant Enterprise Products Partners(NYSE: EPD) and its 6.8% distribution yield. Here’s what you need to know before you buy either one.
Many conservative investors avoid the energy sector because it is inherently volatile. Oil and natural gas are indeed commodities prone to wide and often swift price fluctuations. However, some energy companies are built to withstand the swings while continuing to reward dividend investors well for sticking with them. Chevron stands out currently due to its high yield.
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Chevron is one of a handful of integrated energy companies. This means it operates across the entire energy landscape, including the upstream (oil and gas production), the midstream (pipelines), and the downstream (chemicals and refining). Each segment of the industry operates slightly differently throughout the energy cycle, so having exposure to all three helps to blunt the peaks and valleys caused by commodity price swings.
Additionally, Chevron boasts one of the strongest balance sheets among its peers, with a debt-to-equity ratio of approximately 0.22. That would be low for any company, but the key for Chevron is that it allows the company to add debt during industry downturns. This provides the cash flow to continue to support its business and dividend through the weak patch. When commodity prices recover, as they always have historically, leverage is reduced again.
These two facts have enabled Chevron to increase its dividend annually for 38 consecutive years. That’s an incredible streak given the volatility of the energy sector. The 4.5% dividend yield, meanwhile, is above the energy industry average of 3.2% and more than four times the 1.1% yield offered by the S&P 500 index.
You can get an even higher yield with Enterprise Products Partners. This master limited partnership (MLP) has a distribution yield of 6.8%. The distribution has been increased annually for 27 years, which is basically the length of time that the MLP has been publicly traded.
The way that Enterprise has achieved this feat is by focusing on the most reliable segment of the energy industry — the midstream. It owns the energy infrastructure, such as pipelines and storage facilities, that helps move oil and natural gas around the world. It charges fees for the use of its asset, so the volume flowing through its system is more important than the price of the commodities it is moving. It is a tortoise-like business, but it generates a lot of cash to support its distribution.
On that front, Enterprise’s distributable cash flow covers its distribution by 1.7x, providing ample room for adversity before a distribution cut would be in order. On top of that, the company has an investment-grade-rated balance sheet, suggesting that it could tap the capital markets in a worst-case scenario. The distribution looks far more likely to grow in the future than be cut.
One notable caveat here is the MLP structure. Master limited partnerships don’t play nicely with tax-advantaged retirement accounts, like IRAs. And you will have to deal with some extra tax complications on April 15, notably having to incorporate a K-1 form into your annual filing routine. However, for more conservative dividend investors, the extra work might well be worth the extra yield.
Most investors should have some exposure to the energy sector, given the significant role oil and natural gas play in the world. Chevron and Enterprise offer dividend lovers a way to achieve that without taking on too much risk. Of the two, Enterprise is probably the safer choice. But if you want direct oil exposure, Chevron would be the more appropriate option.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
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