• Mon. Jan 30th, 2023

2 Ultra-High-Yield Energy Stocks to Buy Hand Over Fist and 1 to Avoid

ByThe Motley Fool

Nov 12, 2022
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The world is looking to shift toward clean energy sources, but it can’t easily move away from oil and natural gas. It will likely be decades before these fuels start to see meaningful demand declines. That said, they are commodities prone to material and dramatic price moves.

So if you are a dividend investor looking to own a high-yield energy company, you need to balance risk and reward in a unique way. Enbridge (NYSE: ENB) and Magellan Midstream Partners (NYSE: MMP) are two midstream companies that have reliable dividends and fat yields. Pioneer Natural Resources (NYSE: PXD) has a huge yield today, but “reliable” is not a good way to describe the dividend. Let’s explore why the first two stocks might be worth buying hand over fist and the third might be one to avoid.

Forget about energy prices

Oil and natural gas are commodities where the price is based on supply and demand. Right now prices are fairly high because demand is outstripping supply. Not too long ago, during the early days of 2020 when coronavirus pandemic fears led to a severe drop in demand, the industry was crippled by low prices. Swings like this seem shocking in the short term, but they are fairly commonplace over the long term.

That is one reason why investors might want to look at the midstream space, with high-yielders like Enbridge and Magellan at the top of the list. Enbridge owns oil pipelines, natural gas pipelines, a natural gas utility business, and a small but growing clean energy operation. All of its divisions are driven by either fees or long-term contracts, which makes cash flows highly reliable. The stock’s dividend yield is 6.2%. Magellan owns the infrastructure that moves oil and products oil gets turned into, like diesel fuel. The vast majority of its business is fee-based. The master limited partnership’s yield is a hefty 8.1%.

Basically, energy prices can go up and down, and these two midstream players should sail right through the commodity volatility. The proof of that is in their dividends. Enbridge has increased its dividend annually for over 25 years. Magellan has increased its distribution annually since its initial public offering just over two decades ago.

Of the two, Enbridge is probably the more attractive right now as it continues to invest for growth and has material excess cash flow. Magellan’s higher yield is likely related to the fact that it doesn’t have any notable growth plans at the moment and its distribution isn’t as well covered. That said, the partnership is buying back units as it awaits better capital investment opportunities, so it isn’t sitting idle. Still, given the extreme focus on oil products in a world that is looking to reduce carbon emissions, it is most appropriate for more aggressive types with a contrarian streak.

The downside

Pioneer Natural Resources, meanwhile, highlighted that its third-quarter dividend translates to an annualized yield of roughly 9%. The quarterly payment was a huge $5.71 per share, up materially from the $3.64 per share in dividends announced in the fourth quarter of 2021. But there’s a small fly in the ointment because the energy producer’s dividend is composed of two parts. The base dividend in the fourth quarter of 2022 was $1.10 per share, with a variable supplement of $4.61 per share.

The problem here is that in the third quarter of 2022 the total dividend was $8.57 per share. The variable component fell materially between the third and fourth quarters. Why? Because oil prices have cooled off from higher levels earlier in the year. But more importantly, the dividend is doing exactly what it was intended to do: rise and fall along with the company’s financial results (which rise and fall along with the price of oil). There’s nothing wrong with Pioneer Natural Resources per se, but investors that are looking to create a reliable income stream will be disappointed.

The yield is clearly attractive, but dividend investors looking at the energy sector need to be aware of the inherent volatility in the payout. It just isn’t something that you can rely on by design. And the downside income risk is on clear display right now.

Know what you own

Dividend investing requires more than just examining dividend yields. Enbridge and Magellan own reliable pipeline businesses that support big yields and largely avoid the commodity risk inherent in the oil business. They are the types of stocks that dividend investors can comfortably own even in the face of falling energy prices. Pioneer Natural Resources, however, is specifically rewarding investors based on the price of the commodities it produces. That means the dividend will fluctuate, perhaps wildly, and it’s a risk that investors need to understand, and perhaps avoid if dividend consistency is your focus.

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Reuben Gregg Brewer has positions in Enbridge. The Motley Fool has positions in and recommends Enbridge. The Motley Fool recommends Magellan Midstream Partners and Pioneer Natural Resources. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



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