For dividend investors, one of the most important things to know about the energy sector is that it is highly volatile. That means dividend-paying energy stocks deserve a little extra scrutiny before adding them to your portfolio.
A good example of the problem income investors face when looking for energy investments is Devon Energy (NYSE: DVN).In the meantime, Chevron (NYSE: CVX) And Business Product Partners (NYSE: EPD) are good examples of the gems you can discover in the energy sector if you dig a little deeper.
Devon Energy’s dividend history isn’t shocking
Devon Energy is what is known as an upstream company, meaning it produces oil and natural gas. In this case, the company operates exclusively in the onshore U.S. space, but that is not the most notable factor here.
What is important to understand is that the top and bottom lines are almost entirely driven by energy prices. Oil and natural gas prices are highly volatile, and so Devon’s financial results are also highly variable.
This is not bad in itself. It is pretty much normal when you look at an upstream company. For dividend investors, however, there is an additional problem. Devon’s dividend is variable, with the final payment tied to the company’s financial performance.
Although the dividend yield is listed at 4.4% on major online quote services, investors should expect the actual income received to vary widely over time. In a sense, the variable dividend policy is a good way to ensure that shareholders are rewarded when energy prices are high, but the downside is that dividend cuts are inevitable.
For most income investors, Devon Energy is not a good stock.
Chevron is a reliable dividend payer
If you’re looking for a reliable dividend payer with a long history of annual increases, you’re probably better off with Chevron. For starters, it’s much more diversified. Its business spans upstream, midstream (pipelines), and all the way down to downstream (chemicals and refining).
The company’s energy portfolio is also globally diversified. And it happens to be one of the largest energy companies in the world with a market cap of $260 billion. Chevron’s dividend yield is also around 4.4%.
The energy company has increased its dividend annually for 37 consecutive years, despite the inherent volatility of the sector. A big part of the story here is the rock-solid balance sheet, with a debt-to-equity ratio of just 0.14 times.
That would be strong for any company, but it gives Chevron room to take on debt during industrial downturns so it can support its business and dividend. When energy prices recover, as they historically have, it pays down the debt in preparation for the next energy sale.
If you are looking for an energy producer with a reliable dividend, Chevron is one of the best options you can find.
Enterprise is a boring, high-yield enterprise
If Chevron’s exposure to oil and natural gas production is a bit too much of a concern for you, there are still a number of energy options available. One of the most reliable is Enterprise Products Partners, a master limited partnership (MLP) that manages a large portfolio of midstream infrastructure assets.
Typically, there are fees charged for the use of these assets, so the price of the oil and natural gas flowing through the system is not all that important to the financial results.
This is highlighted by the fact that the company has increased its distribution annually for 26 consecutive years. And there’s more to like. The balance sheet is specifically investment grade, and cash flow covers distribution at a strong 1.7x. There’s a lot of room for adversity before a distribution cut would be on the table.
That said, Enterprise’s hefty 7% or so distribution yield is likely to account for the lion’s share of returns over time, as there is limited growth prospects in the midstream sector.
But bolt-on acquisitions, expansions of existing assets, small ground-up capital projects and regular rate increases within the existing portfolio will likely lead to slow and steady growth over time. And that, in turn, should support continued distribution growth.
The best options for energy income
Dividend investors need to understand the impact that the energy sector’s high volatility will have on their investments. Both Chevron and Enterprise have proven that they know how to navigate the sector’s ups and downs while still rewarding investors well over the long term.
That said, Devon Energy isn’t a bad company, but it has taken a very different dividend approach that inherently means shareholders will see dividend cuts. If you’re looking for a reliable income stream in the energy sector, Chevron and Enterprise are much better choices.
Should You Invest $1,000 In Devon Energy Now?
Before buying Devon Energy stock, you should consider the following:
The Motley Fool Stock Advisor team of analysts has just identified what they think is the 10 best stocks for investors to buy now… and Devon Energy wasn’t one of them. The 10 stocks that made the cut could deliver monster returns in the years to come.
Think about when Nvidia made this list on April 15, 2005… if you had $1,000 invested at the time of our recommendation, you would have $758,227!*
Stock Advisor offers investors an easy-to-follow blueprint for success, including portfolio building guidance, regular analyst updates, and two new stock picks each month. The Stock Advisor has service more than quadrupled the return of the S&P 500 since 2002*.
View the 10 stocks »
*Stock Advisor returns as of August 22, 2024
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.
2 High Yield Energy Stocks You Should Buy Hand Over Hand, and 1 You Should Avoid was originally published by The Motley Fool
