Leading energy companies have improved their balance sheets and are raising their dividends.
The stock market is driven by earnings growth in the longer term. But in the short term, investor sentiment and prevailing themes can capture the spotlight.
Over the last year or two, some of the major catalysts driving the market higher have included the prospect of lower inflation, lower interest rates, and accelerated growth in the tech sector.
Investors looking for different ideas have come to the right place. The energy sector is chock-full of quality dividend-paying companies -- many of which sport inexpensive valuations. If you invest $9,000 into each of the following stocks -- ExxonMobil (XOM 0.90%), Kinder Morgan (KMI 0.41%), and Phillips 66 (PSX 0.79%) -- you can expect to earn over $1,000 a year from dividend income alone. Here's why all three companies stand out as top buys now.
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ExxonMobil's dividend is a core part of its investment thesis
ExxonMobil is the most valuable U.S.-based energy company for good reason. The integrated major has a diversified global upstream portfolio spanning onshore and offshore assets, a massive refinery and chemical business, and a growing low-carbon fuel segment.
Despite its dominant position, ExxonMobil isn't a perfect company. In the past, it has over-leveraged and left itself vulnerable to downturns. ExxonMobil's aggressive approach was partially to blame for amplifying losses in 2020 when the company posted a staggering net loss of over $22 billion.
However, ExxonMobil has improved its balance sheet significantly since then, taking advantage of outsize gains in recent years to pay down debt.
XOM Net Total Long Term Debt (Quarterly) data by YCharts
One of the most important qualities a company can have is to bridge the gap between investor expectations and reality. And with ExxonMobil, the expectations are fairly straightforward. The company pounces at the opportunity to make an acquisition -- as was the case in October when it announced its largest deal in over 20 years to acquire Pioneer Natural Resources. In December, it laid out a clear corporate plan that included capital spending, free-cash-flow (FCF), earnings, and cost-saving estimates through 2027. Better yet, the corporate plan is centered around $60 per barrel of Brent crude oil (Brent crude is currently around $78 per barrel).
ExxonMobil has paid and raised its dividend for 42 consecutive years -- making the company a stable passive income producer. With a yield of 3.2% and a reasonable 14.2 price-to-earnings (P/E) ratio, ExxonMobil stands out as a balanced buy now.
Kinder Morgan is making a comeback
It's been a long time coming, but Kinder Morgan stock has finally blasted to a new five-year high after underperforming the market for several years. The midstream company doesn't make money from producing or refining oil and natural gas, but rather by transporting and storing fuels and charging customers fees. It's a win for Kinder Morgan because it collects predictable cash flows and a win for its customers so that they don't have to shell out multibillion-dollar capital investments to transport fuels from areas of production to areas of consumption and export.
Kinder Morgan has become one of the energy sector's most reliable dividend stocks. But it wasn't always this way.
The company paid a $0.51-per-share quarterly dividend in 2015, cut it by 75% during the industrywide crash that year, and has since been working to build it back up. The latest quarterly payout was $0.2875 per share -- still down significantly from nine years ago but good for a yield of 5.4% based on Kinder Morgan's current stock price. So what kinder Morgan lacks in the track record department, it makes up for with a sizable payout.
Better yet, Kinder Morgan's prospects for growing FCF and earnings to support its growing dividend look bright. The company has reduced its leverage by paying down a sizable amount of debt and taking a cautious approach to capital expenditures. It has made a few acquisitions here and there, but nothing that would jeopardize its financial health. The midstream industry is chock-full of potential thanks to the growing U.S. liquefied natural gas industry; the need to transport low-carbon biofuels, hydrogen, and drop-in replacements to fossil-based natural gas such as biomethane; and growing demand for electricity consumption from data centers.
On its second-quarter 2024 earnings call, Kinder Morgan discussed the potential for artificial intelligence (AI)-driven data center demand to be a catalyst for natural gas to help fuel a growing grid. It remains to be seen if tech companies will power data centers with natural gas -- since many are focusing on strict energy transition goals and renewable energy projects. But regardless, the role of natural gas in the future energy mix looks strong if domestic consumption remains stable and the export market continues growing.
Add it all up, and Kinder Morgan looks like it's in its best position in several years.
Phillips 66 can afford its expensive capital return program
Phillips 66 is in a somewhat similar boat as Kinder Morgan, just on the downstream side of the business. The company has kept a lid on capital expenditures and is diversifying its business to tap into low-carbon fuels. Phillips 66 makes money from turning crude oil into refined products. But it has transformed its San Francisco Refinery to produce 30,000 barrels per day (bpd) -- soon to be 50,000 bpd -- of renewable diesel fuel from cooking oil, fats, greases, and vegetable oil instead of fossil fuels.
Phillips 66 has been ramping up its buyback and dividend programs by reducing its share count by over 10% in the last two years and increasing the dividend by nearly 20%.
Throughout its recent investor presentations and earnings calls, Phillips 66 has clarified that it intends to return capital to shareholders through buybacks and dividends. Despite substantial increases to the dividend, Phillips 66's payout ratio is just 32% -- meaning it is distributing just $0.32 for every dollar in earnings toward the dividend.
In a perfect world, downstream companies like Phillips 66 prefer to buy crude oil for dirt cheap prices and make high margins from refined products. But they can do very well even during higher price environments if they can pass along costs to customers, which Phillips 66 has done. Ultimately, what downstream companies want is consistent oil prices so that they can budget capital investments and not be blindsided by market volatility. The last two years have been about as consistent as you can find in the oil patch, with Brent and West Texas Intermediate crude oil prices fairly range-bound between the high-$60-per-barrel mark to the low $90s per barrel. That's a wonderful range for upstream producers like ExxonMobil that are budgeting around at least $60 oil. But it's also been suitable for Phillips 66, whose capital return program has benefited from the price consistency.
Brent Crude Oil Spot Price data by YCharts
All told, Phillips 66 and its 3.3% yield are a solid source of passive income -- especially for investors who look for companies that return capital to shareholders through buybacks and dividends.
Three great choices to add to a diversified portfolio
While investing $9,000 into each of the discussed stocks would produce over $1,000 in dividend income per year, it's important to make sure that your investment decisions take allocation into account. Going all in on a single sector is usually a bad idea. Diversifying your portfolio across top best picks from different sectors can help keep volatility at bay while getting exposure to different parts of the economy.
Another mistake is to feel like you have to jump at an opportunity and establish a whole position at once. A better approach could be to dollar-cost average into a position over time by gradually growing the holding. That way, you can better control allocation and ensure that no individual position becomes too large or you're accidentally taking on more risk in a certain sector or theme than you intended.
Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Kinder Morgan. The Motley Fool has a disclosure policy.
